Reluctance to sell results in overdiversification

“About half of my investments are equities with a decent yield and are intended to ensure that I have enough income in retirement, and to meet the costs of home or long-term residential care in later life, if necessary," says Paul. "I want the rest of my investments to achieve the maximum possible growth. Although I have no direct dependents, I have quite a large family and want to leave a large amount of capital to five or six of them – as much as possible.

"I have been investing in equities for about 30 years, after inheriting shares from my parents. I use my full Isa allowance every year to invest £2,000 a month into FTSE 100 companies. I also pay small amounts into a Sipp on a regular basis.

"As my investments are worth over £1m I could afford to lose up to three-quarters of their value and still live comfortably, so I think it is worth targeting higher risk investments. I would be happy for my investments to lose 30-50 per cent of their value in any given year, although I think this is very unlikely as many of my investments are FTSE 100 companies. 

"If the market fell I would top up my holdings in Unilever (ULVR) and Diageo (DGE). These shares have risen so much their yields have dropped to around 2 per cent [at time of writing], making them far too expensive. I bought them when they had yields of around 3.5 per cent. I almost never buy shares without a yield – even in the case of smaller companies – a reason why my Sipp includes 4imprint (FOUR). I like this company’s return on capital. 

I mostly buy and hold investments, and am an admirer of the investment styles of fund managers Terry Smith, Nick Train and Warren Buffett. 

"For the past 10 years I have aimed to have global exposure, including to smaller companies, private equity and venture capital, and emerging and frontier markets. So I invest in direct shareholdings such as BP (BP.) and Royal Dutch Shell (RDSB), which have global reach, and companies expanding into emerging markets such as Unilever, Diageo and Reckitt Benckiser (RB.). I also aim to get exposure to these areas via BMO Global Smaller Companies (BGSC), Scottish Mortgage Investment Trust (SMT) and Edinburgh Worldwide Investment Trust (EWI).

"I invest £100 every month into Baillie Gifford Shin Nippon (BGS), Scottish Mortgage Investment Trust, Edinburgh Worldwide Investment Trust, Fundsmith Equity (GB00B41YBW71) and Lindsell Train Global Equity (IE00BJSPMJ28). These funds have each gained about 15-20 per cent every year, on average, since I invested in them. But I also like to keep costs down so only hold active funds if they beat their benchmarks by a mile year after year. If they were to start underperforming I would have no hesitation in selling them.

"I recently sold JPMorgan US Smaller Companies Investment Trust (JUSC) because I thought its ongoing charge [of 1.36 per cent] is too high, and instead get exposure to the US via Scottish Mortgage Investment Trust, which has an ongoing charge of 0.37 per cent. I reinvested the sale proceeds in Stock Spirits (STCK), a small company listed on the Alternative Investment Market (Aim) which sells premium spirits in eastern Europe. Wealth is growing in countries such as Poland and this company sells an addictive product. I hope that Stock Spirits will become the next Diageo, or be taken over by it.

Paul's investment portfolio

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

THE BIG PICTURE

Chris Dillow, Investors Chronicle's economist, says:

You are doing many things right. I like that you try to keep costs down by avoiding expensive active funds and are making full use of your Isa allowance. Your interest in private equity and venture capital is good because, increasingly, the stock market is not the place to find the best growth companies and many companies only list on markets at the peak of their fortunes. A disproportionate amount of investment growth in future years may come from unquoted companies, and funds that invest in private equity give you exposure to that potential.

Your aversion to stocks with no yield is also praiseworthy because these tend to be the most speculative ones. However, these have tended to be overpriced, on average, because investors pay too much for the small chance of big gains and not enough for 'get rich slow' companies. This is a reason why Aim stocks have underperformed the FTSE All-Share index so much since the mid 1990s.

You are wise to run winners, subject to a caveat. Much of the time, momentum happens when investors underreact to good news, which causes a stock to be underpriced after it has enjoyed such news, with the result that it rises on the news but not by enough, so continues to rise later. But if you are reluctant to sell you could end up with an unwieldy, overdiversified portfolio as you add assets over time without selling. So you end up with, in effect, a global tracker fund, only acquired at greater expense and trouble.

Also consider how much you should rely on return on capital figures when picking stocks. One problem with this is scalability – a small company might have a good return on capital but be unable to maintain it as it grows. This could be because growth requires high capital spending or the company faces various problems with economies of scale.

Another problem is that high returns are a signal for rival companies to enter the market, thereby competing profits away. So you should not just look for a good return on capital but what Warren Buffett calls "economic moats" – sources of monopoly power that a company can use to exclude rivals and maintain profits. Diageo, for example, has powerful brands such as Guinness and Johnnie Walker. Does Stock Spirits really have comparable ones?

The stocks you have bought on the basis that they have global reach are, for the most part, moat stocks. Some have the monopoly power from branding, for example Unilever and British American Tobacco (BATS). And others have it because they operate in areas that require high capital requirements, for example Royal Dutch Shell. So by investing in these you have done the right thing.

But there’s a danger that stocks such as Unilever and Diageo have become too expensive. It’s possible that having wrongly neglected the importance of moats for years, investors have now wised up to this mistake and might be paying too much for them. A similar thing happened to small-cap stocks, which were underpriced until the 1980s. Investors cottoned on to the underpricing and drove their prices up to such high levels they suffered from a decade of underperformance. That episode warns us that, sometimes, you need to sell after long periods of success.

Keith Bowman, equity analyst at interactive investor, says:

You are sensibly using tax-efficient wrappers such as Isas to safeguard investments from the taxman. And drip-feeding money into the stock market via monthly savings schemes avoids the issue of timing, averaging out the peaks and troughs. This is something all investors should consider using.  

You should start to address the inheritance tax (IHT) your heirs are likely to face. If you die in the near future, a house worth £700,000 and a £1m-plus investment portfolio would be likely to leave your beneficiaries with a sizeable tax bill.

A professionally drafted and up-to-date will would be a good starting point, and professional tax advice on whether to make lifetime gifts. Also remember that assets within a Sipp are usually outside your estate for IHT purposes. So consider doing a 'bed and Sipp': selling investments, offsetting any profits against your annual capital gains tax (CGT) allowance, which is currently £12,000, and then repurchasing them within your Sipp. But seek professional tax advice before doing anything.

HOW TO IMPROVE THE PORTFOLIO

Keith Bowman says:

Your portfolio is a good example of how patient investing can work. Having the conviction to buy and patiently hold is often much easier said than done. Warren Buffett once said that "the stock market is a device for transferring money from the impatient to the patient".

The aim of your investment strategy is balanced income and growth over the long term, with a medium to higher risk tolerance. Your investments are highly diversified, but you may be duplicating holdings as you have several funds focused on emerging markets and smaller companies. And you hold Unilever and Diageo directly, but these are also among Lindsell Train Global Equity Fund's top 10 holdings.

You already have more than 40 investments, so if you add more the portfolio will become increasingly difficult to oversee.

Dennis Hall, chief executive officer of Yellowtail Financial Planning, says:

It’s hugely encouraging to find people with modest incomes who have managed to accumulate significant portfolios. Their secret is usually down to formulating a plan, doing the necessary research and work, and then sticking to the plan – typically over a long time. A buy-and-hold strategy, and a keen appreciation of costs, have also contributed to overall returns.

You follow four themes: global, small-cap, private equity and venture capital, and emerging and frontier markets. However, global large-caps account for almost half of your investments and just two shares – Royal Dutch Shell and BP – account for almost a quarter. That is a high allocation – even for a high-conviction investor. And even if you sell some of your holdings in these every year, offsetting the gains against your annual CGT allowance, it would still take several years to reduce them.  

Your portfolio is also more complex than I’d like. I favour simplification to the point that most of my portfolio is invested in six funds. Many people who are uninterested in managing a portfolio could simplify things even further by holding just two funds – a global equity and global bond fund.

You like managers who take a high-conviction approach. I’ve been a fan of another high-conviction investor – Keith Ashworth-Lord – who runs CFP SDL UK Buffettology Fund (GB00BF0LDZ31), although I dislike this fund's open-ended structure. However, you also invest in funds with significantly larger numbers of holdings, including ones that invest in other funds, diluting and diversifying the underlying investments even more. This makes it difficult to track your holdings and know whether you’re duplicating exposure to certain holdings. For example, you have a direct holding in 4imprint, but at least one of your funds, BlackRock Smaller Companies Trust (BRSC), also holds it. From a risk perspective diversification is a good thing, but unless you’re index tracking, too much diversification is not a good thing.

Your global and emerging markets exposure is difficult to follow, so I would simplify it by pruning the number of holdings in this area. I favour going global on a market cap weighting basis, and would have an overweight in emerging and frontier markets by choosing one fund focused on each of these two areas. It’s hard enough researching individual domestic stocks let alone trying to successfully forecast the global economy – something that seems to evade most analysts most of the time.  

I too like private equity, but the charges on these types of funds tend to be higher. I’ve long been a fan of HgCapital Trust (HGT) and made good returns with Electra Private Equity (ELTA).