Do my holdings reflect my risk appetite?

“I retired in 2016, and have drawn the natural yield of around £35,000 a year from our investments,” says Sandy. “My wife has a former employer pension that pays her £4,000 a year and we take up to £10,000 a year from our savings as we do not yet receive state pensions. I take this money from different accounts to minimise tax."

"My long-term goal is to maintain our net wealth in line with consumer price index inflation (CPI). I’ve made 7 per cent in the three years since I retired, but my goal is an income of 5 per cent a year and growth in line with CPI.

"I’ve actively managed my finances and pensions since 2009 when I moved three defined-contribution schemes into my self-invested personal pension (Sipp), after their value plunged when markets fell in 2008. Since then I’ve made hefty contributions to my own and my wife’s Sipps, invested the full annual allowance in individual savings accounts (Isas), and reduced my tax by investing in venture capital trusts (VCTs). If I count the tax relief I get with the VCTs, they have been among my better-performing investments. On average, they generate dividends of about 5.5 per cent a year, which are tax-free.

"As I approached retirement, I switched from growth funds into income funds, but felt that a lot of the dividends I was receiving were swallowed up by their charges. I now mainly invest in investment trusts, but this does not seem to be cutting my fees. There is also a far smaller choice of investment trusts than open-ended funds, so I have been reluctant to transfer my open-ended fund holdings into my larger investment trust holdings. So I am considering switching most of them into one or more passive funds.

"However, I like active funds whose performance justifies the relatively higher fees. For example, I have done well out of Bluefield Solar Income Fund (BSIF) [which has an ongoing charge of 1.05 per cent], although SQN Asset Finance Income Fund [which has an ongoing charge of 1.65 per cent] has not been such a successful investment. 

"I also really like Royal London Sterling Extra Yield Bond (IE00BJBQC361) and Lindsell Train Global Equity (IE00B644PG05).

"I invest in various asset classes that generate an income, including bonds, energy resources, infrastructure and real estate. For example, I have recently invested £3,000 in Shires Income (SHRS) and £5,000 in CQS New City High Yield Fund (NCYF).

"I am also switching assets worth £20,000 in my Sipp into smaller companies, which I will trade actively. For example, I have recently invested £1,000 in Bloomsbury Publishing (BMY).

"I would say that I have a relatively high risk appetite, which is probably reflected in my investment strategy and holdings, and would be prepared for my investments to fall in value by 15 per cent in any given year. But I would like an assessment of my level of risk, and wondered what other assets or funds I should consider?"

Sandy and his wife's investment portfolio

Source: *Morningstar, **Association of Investment Companies

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:

There’s a paradox here – although you say you are pretty risk tolerant this is not really reflected in your portfolio. You have a decent weighting to relatively defensive stocks via funds such as EdenTree Higher Income (GB0009449827), Murray Income Trust (MUT) and Shires Income, and relatively low weightings to what are generally considered to be risky assets, such as emerging markets and commodity stocks.

But you have an unusually high allocation to bonds, many of which are higher-yielding. I wonder how much more mileage there is in these? Recent years have been great for them. Economic growth has reduced investors’ perceptions of credit and liquidity risk, while falling yields on government bonds have caused increased demand for any asset with a reasonable yield.

This, however, means that these types of bonds face two opposing risks. One is recession, and inverted yield curves in the UK, US and eurozone warn that there is a danger of this. Such events usually result in a flight to quality assets such as government bonds, and exits from higher-yielding assets that investors think expose them to default and liquidity risk.

The other danger, which seems less imminent, is higher interest rates when the threat of recession passes. This could reverse the reach for yield that has favoured corporate bonds, and cause investors to generally switch out of bonds and into more growth-sensitive assets such as equities.

Right now, higher-yielding bonds are in a sweet spot and neither of these risks have materialised. But I’m not sure that this will remain the case. There’ll come a time when you might want to lighten your holdings in them by shifting to equities in good times, and to cash or government bonds in bad times.

There are two indicators to watch for, one of which is the US yield curve. When 10-year yields are below the Federal Reserve funds rate this is a warning to be light on equities. And equities are a better investment when their prices are above the 10-month or 200-day moving average than when they are below it. Just now, the FTSE All-Share and S&P 500 indices are just above this average. Other positive signs for equities are the relatively high UK dividend yield and foreign investors being net sellers of US stocks, a sign that sentiment is weak and a lot of bad news is already in the price.

So there might be a case for shifting towards equities, but I understand if you are reluctant to do this while the yield curve is inverted.

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

Your desire for an annual index-linked income of 5 per cent plus capital growth in line with CPI is ambitious. Over the 11 years you have been investing it’s been relatively easy to make money, but these have been unusual times.

I’m struggling to see how your portfolio relates to your stated rationale and requirements. Your portfolio represents the attitude of an investor who is “pretty risk-tolerant” but doesn’t reflect that of one who is only comfortable with a maximum 15 per cent loss over one year. If something like the 2008 financial crisis happened again, this portfolio could easily fall 40 per cent in value – and probably more.

I don’t think your equity holdings are the biggest problem, rather it’s the exposure to high-yield bonds in the higher-yielding funds, some of which have more than 50 per cent of their assets in such securities. A high natural bond yield comes with a high risk to capital. To get an idea of how risky, look at the performance of Artemis High Income (GB0006838097) peak to trough during 2008.

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

What matters is total return. If this is good, you can create your own dividends by realising capital gains.

You have a substantial allocation to VCTs, which I think is wise, but not for the usual reason. It’s often a bad idea to buy assets for tax breaks because these are often reflected in their prices, meaning that what you gain from the tax break is lost from paying too much. Rather, the case for VCTs is that a lot of corporate growth comes from unquoted companies – the poor performance of many companies after they are listed on markets is consistent with this. And VCTs give you exposure to such unquoted corporate growth.

But you need to diversify across managers because their performance can be very variable – one or two great investments can make a huge difference to a VCT's overall returns.

Dennis Hall says:

The charges you are paying are high because you hold the most expensive share class of several funds. It’s worth having a look at what share classes of these funds other investment platforms offer to see if you can move to one that offers cheaper ones [if they are not available on the platform you currently use]. Even if this means a slightly higher platform charge, it’s likely to be less expensive overall.

I don’t believe I can consistently identify the best performing fund manager in each sector, so I use index-tracking and passive funds. Some investors prefer active funds, and if you go for these there's not much benefit in diversifying across different managers in the same sector. By doing this you’re either diluting each manager’s advantage or compounding their bad ideas because their largest holdings are similar to each other. So you might as well buy the index.

For example, the outperformance of Lindsell Train Global Equity, has been diluted by Lazard Global Equity Income (GB00B7YWW378) and Liontrust Global Income (GB0007010795), which have underperformed their benchmarks. This is also the case with other sectors to which you are getting exposure to via more than one fund.

Consider getting your global equity exposure via one fund – the one you believe is the best. And do the same for the other sectors you’re invested in. Don’t hedge by including what you think are the second and third best options, as you’re likely to be wrong and setting yourself up for regret. If you can’t do that then forget active funds and buy the whole index via passive funds.

Leonora Walters, personal finance editor at Investors Chronicle, says:

You have tried to cut your fund costs by investing more in investment trusts than open-ended funds, implying that you think investment trusts are cheaper than open-ended funds. But investment trusts have been found to cost more, on average, than the cheapest share classes of open-ended funds.

Smaller and more esoteric investment trusts, in particular, have particularly high ongoing charges and you hold a number of these in your portfolio. You also hold a number of investment trusts focused on more mainstream assets that charge a lot more than many open-ended funds and cheaper investment trusts focused on these areas. For example, CQS New City High Yield, a bond fund, has an ongoing charge in excess of 1 per cent, whereas some of the best open-ended bond funds have much lower ongoing charges – as your holding in Royal London Sterling Extra Yield Bond demonstrates.

Likewise, TwentyFour Income Fund (TFIF) and TwentyFour Select Monthly Income Fund (SMIF) have ongoing charges of over 1 per cent. But the company that runs these funds, TwentyFour Asset Management, runs a number of open-ended bond funds with much lower charges.

Henderson Far East Income (HFEL) has an ongoing charge of over 1 per cent, but there are Asian equity income funds available with lower charges. Shires Income has an ongoing charge of 1.39 per cent but there are other UK equity income open-ended funds and investment trusts with much lower ongoing charges – as your holding in City of London Investment Trust (CTY) demonstrates.

And BlackRock North American Income Trust (BRNA) has an ongoing charge of 1.08 per cent, but you can pick up US equity income funds for much less.

So totally avoiding open-ended funds and buying investment trusts – regardless of what they charge - is not the answer. Instead, do what Dennis Hall suggests – switch the expensive share classes you hold for cheaper ones in the same funds. You should enquire as to whether the platform you invest via offers cheaper share classes and maybe switch into them. Or move to another platform with cheaper share classes.

I have set out in the following table what you would pay for the cheapest share classes of some of the funds you hold on three investment platforms commonly used by self-directed private investors – Hargreaves Lansdown (HL), Interactive Investor (ii) and AJ Bell Youinvest.

This, of course, doesn’t mean you should avoid investment trusts as some of them – such as City of London Investment Trust and Scottish Mortgage Investment Trust (SMT) – have some of the lowest charges of all active funds. If you want to minimise costs, look at how much every fund costs and compare it with ones that invest in the same type of assets. Don’t just pile into one type of fund structure in the mistaken assumption that it is cheaper.

Of course, don’t forget to add in the effect of platform fees. Some platforms apply different holding and trading charges to funds with different structures, for example Hargreaves Lansdown. If there is a difference then there could be an argument for favouring one type of fund structure over another – or switching to a platform where it is cheaper to hold the funds you want.

You also said you are going to put £20,000 of your Sipp into smaller companies and trade them actively. But trading direct shareholdings incurs a charge, so frequently churning this type of security will ramp up your costs. And if you invest a very small percentage of your portfolio into one holding, even if it does well over the short period during which you plan to hold it, it will not have much of an effect on your overall return – but the trading charges will eat into your returns.

If you are very keen to cut your costs of investing, having fewer holdings as Dennis suggested and not constantly trading them (if there is a charge to do this) could help.