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Our reader's portfolio doesn't match his risk appetite
September 6, 2018, Patrick Connolly and Adrian Lowcock

Jonathan is age 56, and wants to retire at  58 and travel for two years. When he turns 60 he plans to supplement his £17,000 a year defined benefit (DB) pension with income drawn from his portfolio. He will also receive a full state pension when he turns 66. Jonathan is single, has no dependents and is happy to run down his portfolio in its entirety.

Reader Portfolio
Jonathan 56
Description

Isa and trading account invested in funds

Objectives

Our reader's income and risk objectives could be better met

Portfolio type
Investing for income

“I want to spend the next two years restructuring the portfolio so that it can start paying me an income by the time I turn 60,” says Jonathan. “I have been investing for seven years and can save around £17,000 a year into my individual savings account (Isa) until I retire. I will be likely to have a £50,000 lump sum to invest when I am 60.

“I want to have an income of 5 per cent a year from the portfolio until I am 66 when I think I will be able to start withdrawing capital.

“I have never sought financial advice, so I have invested in funds as I feel they are the safest and most sensible option. I think I have a moderate attitude to risk and would not want to see my portfolio fall more than 10 per cent in a 12-month period.

“I save every month, usually £1,600, and top up existing holdings – especially if the price has fallen recently. Or I invest in a new fund that gives me a different exposure to what I have already.

I have recently invested in the Jupiter India (GB00BD08NQ14), Schroder US Mid Cap (GB00B7LDLV43) and FP Crux European Special Situations (GB00BTJRQ064) funds. And I am thinking of investing in iShares Emerging Markets Equity Index Fund (GB00BJL5BW59).”

 

Jonathan’s investment portfolio

HoldingValue (£)% of portfolio
LF Woodford Equity Income (GB00BLRZQC88) 26,08726.46
HL Multi-Manager Special Situations (GB00BVYV7593)10,46210.61
Aberdeen Latin American Equity (GB00B41QSW23)9,0519.18
AXA Framlington Biotech (GB00B784NS11)8,9059.03
HL Multi-Manager Asia & Emerging Markets (GB00BSD99P77)7,7997.91
JPMorgan Emerging Markets (GB00B1YX4S73)6,8226.92
Marlborough Multi Cap Income (GB00B907VX32)6,5106.60
Jupiter India (GB00BD08NQ14)5,5695.65
Old Mutual Global Equity (GB00B1XG9821)4,9595.03
FP Crux European Special Situations (GB00BTJRQ064)4,5474.61
HL Multi-Manager European (GB00BSD99K23)3,5303.58
HL Multi-Manager Income & Growth (GB00BVYV7601)2,6862.72
Schroder US Mid Cap (GB00B7LDLV43)1,6531.68
Total98,581 

 

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:

You’d like an income of 5 per cent a year from this portfolio. But income stocks and funds carry distinct risks. One is cyclical: some income stocks, most obviously housebuilding companies, will slump when the next recession hits.

Income investments also incur political risk. Utilities, and perhaps telecoms, have high yields to reflect the risk that the next government might nationalise or regulate them more heavily.

A third danger is that investors have wised up. In the past, some income stocks have tended to be underpriced because investors have underestimated the growth that companies can enjoy even in mature markets simply by having brand power. This has been the case with tobacco stocks, and the likes of Unilever (ULVR) and Diageo (DGE). It’s possible, though, that investors have now realised this and as a result driven the prices of such shares too high. If this is the case, future returns will be poor.

So you should be wary of investing for income. Instead, invest for total return. You can create income by selling some of your assets. If you do this your aspiration of taking an income of 5 per cent from the portfolio each year is quite reasonable, given that you can afford to run down your capital.

 

Patrick Connolly, chartered financial planner at Chase de Vere, says

When constructing an investment portfolio, the starting point should be the asset allocation. A broad spread of, say, 60 per cent in equities, 30 per cent in bonds, and 10 per cent in bricks-and-mortar property.

You say you have a moderate attitude to risk but your investment portfolio is very high risk. There is a mix of funds that seems to have been put together with little coherent strategy, which has probably worked while markets have performed strongly, but risks significant capital losses if markets fall.

You can take some risks because of the security of your DB pension. But you have over 38 per cent of your portfolio in high-risk emerging markets, Latin America, India and biotechnology funds, and over 26 per cent invested just with Neil Woodford.

About 25 per cent is invested in Hargreaves Lansdown multi-manager funds. These can provide good diversification but can also be expensive. The four funds you hold have annual charges of between 1.3 and 1.6 per cent, which doesn’t include Hargreaves Lansdown's platform charge of 0.45 per cent on the first £250,000 invested.

These funds also duplicate some of your other holdings. For example, HL Multi-Manager Special Situations Trust (GB00BVYV7593) holds FP Crux European Special Situations  and LF Woodford Equity Income (GB00BLRZQC88), and HL Multi-Manager Income & Growth Trust (GB00BVYV7601) holds LF Woodford Equity Income and Marlborough Multi Cap Income (GB00B907VX32). HL Multi-Manager Asia & Emerging Markets (GB00BSD99P77) holds JPMorgan Emerging Markets (GB00B1YX4S73) and HL Multi-Manager European (GB00BSD99K23) also has an allocation to FP Crux European Special Situations.

You need to compare your guaranteed income with likely expenditure to determine the income you need to generate from your investments, in particular to meet basic living costs. Your target of a 5 per cent annual income will not be possible without taking excessive risks. Instead, make sure you have the right portfolio to match your risk appetite and take the natural level of income produced. If you need more take capital withdrawals, but the more you do this the more the portfolio's value will reduce.

 

Adrian Lowcock, head of personal investing at Willis Owen, says:

You want a 5 per cent income in four years’ time but don’t like the idea of losing more than 10 per cent in any one year. However, your portfolio is not set up to meet these objectives.

It is positioned for growth and is significantly higher risk than you are comfortable with. It is entirely invested in equities, with 30 per cent in emerging markets, and no exposure to other assets such as property and bonds to provide diversification and reduce volatility. This portfolio could fall more than 10 per cent in any given year and, in extreme cases, 30 per cent or more.

The portfolio doesn’t yield much but this can be changed. However, a target yield of 5 per cent is challenging with your risk tolerance. A yield of between 3.5 per cent and 4 per cent is more realistic.

 

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

You are taking on more risk than you realise. You don’t want to lose more than 10 per cent in a year. However, with its exposure to highly volatile emerging markets this portfolio exposes you to such a risk. Stock markets are highly correlated – at least over short periods of less than a few years. Falls in one market are usually accompanied by falls in others. You cannot easily spread risk with equities alone.

But you have a large non-equity asset. The index-linked pension you’ll get from age 60 is equivalent to having an index-linked bond investment of over £500,000. That’s a massive safe asset, which might allow you to take on equity risk. But if you don’t like the thought of losing 10 per cent or more a year, still consider cutting your emerging markets exposure.

From this perspective, your plan to top up funds when their price falls is dangerous – never try to catch a falling knife. Stock markets, and especially emerging markets, are prone to momentum – falls sometimes lead to further falls. Buying on dips is dangerous because sometimes markets suffer much more than a dip. History tells us that the losses we incur in these events outweigh the smaller profits we make from buying on dips.

So, instead of topping up after losses, I’d suggest the opposite – the 10-month average rule. Sell when prices fall below their 10-month or 200-day moving average, and buy when prices rise above it. Apply it only once a month, to avoid unnecessary activity. This rule has worked especially well in emerging markets but right now it is warning us to cut emerging markets exposure.

Keep an eye on charges as these compound horribly over time. You can often get exposure to the asset class you want more cheaply, for example, with passive exchange traded funds (ETFs) or other cheaper active funds invested in the given area.

 

Patrick Connolly says:

You need to think about capital protection and capital growth, so you should diversify the portfolio. Reduce exposure to specialist high-risk regions and introduce assets such as bonds and property. Also make sure you have cash savings for short-term emergencies – if you don't already have some.

You have some good funds which can be retained. But I would get rid of the riskiest ones such as those invested in Latin America, India and biotechnology. Also reduce exposure to Neil Woodford and reconsider the merits of the multi-manager funds.
 
Alternative options include HSBC FTSE All Share Index (GB00B80QFX11), Liontrust Special Situations (GB00B57H4F11), HSBC American Index (GB00B80QG490), Old Mutual North American Equity (GB00B1XG9G04), Invesco Perpetual Asian (GB00BJ04DT45), Fidelity Strategic Bond (GB00B469J896), Janus Henderson Strategic Bond (GB0007502080), Rathbone Ethical Bond (GB00B7FQJT36) and M&G Property Portfolio (GB00B89X8P64).

You will receive a lump sum of £50,000 from your pension at 60. But consider market timing – you can negate the risks of investing money at the wrong time by investing in a diversified portfolio or investing over time. Continue to use your annual Isa allowance.

 

Adrian Lowcock says:

I would suggest a significant overhaul. Remove the funds of funds as they are expensive, and lead to duplication and over-diversification. And remove the specialist funds such as the biotech, Indian and Latin American equity ones. 

Add some income-generating investments, but reduce exposure to LF Woodford Equity Income so that it accounts for no more than 10 per cent of your portfolio.

You also need to introduce other assets. Exposure to bonds and property would provide alternative income streams. It is important to have different sources of income to help provide a reliable, steady income that can grow over time and is not as susceptible to cuts. This can be just as - if not more - important than having a high yield to start with.

The suggested portfolio below takes into account your desire to limit falls to no more than 10 per cent – although this cannot be guaranteed. Due to this, the income it generates falls short of your 5 per cent yield target. To get a higher income you would need to take more risk.

 

Adrian Lowcock's suggested portfolio

HoldingValue (£)% of portfolioYield (%)Income (£)
Artemis Strategic Bond (GB00B2PLJS27)9,8009.943.97389.06
Legal & General UK Property Trust (GB00BK35DT11)9,8009.943294.00
LF Woodford Equity Income9,8009.943.55347.90
Standard Life European Equity Income (GB00B71L0M27)9,8009.943.57349.86
JPMorgan US Equity Income (GB00B3FJQ599)9,8009.941.78174.44
Newton Real Return (GB00BSPPWS71)8,9819.112.29205.66
Jupiter Asian Income (GB00BZ2YMT70)7,0007.104280.00
JPM Emerging Markets Income (GB00B5N1BC33)7,0007.104.16291.20
Man GLG Japan CoreAlpha (GB00B3F47512)7,0007.102.44170.80
Threadneedle High Yield Bond (GB00B7SGDT88)4,9004.974.4215.60
M&G Corporate Bond (GB00B1YBRM66)4,9004.973.65178.85
Schroder Income Maximiser (GB00BDD2F083)4,9004.977.08346.92
Marlborough Multi Cap Income (GB00B908BY75)4,9004.974.36213.64
Total98,581 3.513,458