Chris and his wife are 68, and retired. They have Isas worth about £970,000 and Sipps worth about £1.1m, and each of the accounts has the same holdings and asset allocation as the one below. Their home is worth about £900,000 and mortgage-free.
Isas and Sipps invested in funds, cash, residential property
Supplement pensions with income from investments, income of £50,000 a year, grow assets as much as possible while limiting capital losses, pass on assets to grandchildren
"We want to amass as must capital as we can via both income and capital appreciation,” says Chris. “We calculate that we could live very comfortably on a tax-free income of £50,000 a year, but our two state pensions only add up to £21,000 a year. So we are drawing down the 25 per cent tax-free entitlements from our self-invested personal pensions (Sipps) to bridge the gap. We also add the maximum amount possible each year to our individual savings accounts (Isas) [currently £20,000] and should be able to do this for another two years.
"We have about £150,000 pensions tax-free cash left, sand when we have used that up we will supplement our state pensions with income from our Isas. If we need anything more than that we will cash in some of the capital value of our Isas. So we do not anticipate touching the remainder of our pensions, and intend to pass on everything that remains in them and any other assets that are left after our deaths to our grandchildren.
"We also invest in bare trusts junior Isa for our grandchildren.
"Income has always been an important part of my own and my wife's investment objectives but also want reasonable capital growth.
"I aim to restrict any fall in the value of our investments to no more than 15 per cent, or half of what broader equity markets fall by, if that is less, in any given year. At the end of 2018, when equity markets fell quite heavily, the value of our investments fell by less than 8 per cent, maybe because we diversify our investments across mainstream asset classes.
"In 2019 we sold LF Lindsell Train UK Equity (GB00BJFLM156), which had done very well for us earlier in the year, and global funds with a ‘quality’ investment style that seemed to go out of favour in the second half. And after the election was called we started to add to UK mid and small-cap funds as we thought that the valuations of these assets had suffered since the Brexit referendum.
"We were concerned that sterling would rise to the levels it was trading at before the referendum, so hedged as much of our foreign exposure as possible by moving into sterling hedged share classes of funds that offered them, for example Brown Advisory US Equity Growth (IE00B4MHR723) and Lindsell Train Japanese Equity (IE00B3MSSB95).
"We haven’t had much exposure to emerging market funds since the end of 2018 because we thought that interest rates might rise, but this year could be different. We think that Brazil is the momentum play here and could have a very good 2020, so are considering BNY Mellon Brazil Equity (IE00B90P3080).
"We find it difficult to get much value from investment trusts, but might add Caledonia Investments (CLDN, and top up Standard Life Private Equity Trust (SLPE) and International Biotechnology Trust (IBT) because they are on discounts to net asset value (NAV).
Chris' wife's Sipp
|Holding||Value (£)||% of the account|
|Brown Advisory US Equity Growth (IE00B4MHR723)||14,982.52||2.37|
|Capital Group Global High Income Opportunities (LU0817817702)||17,430.09||2.76|
|Castlefield CFP SDL UK Buffettology (GB00BKJ9C676)||15,304.29||2.42|
|Fidelity Global Health Care (LU1033663300)||17,007.86||2.69|
|Franklin UK Mid Cap (GB00B8K8HH50)||15,487.02||2.45|
|H2O Multireturns (GB00BFNXSG29)||14,863.72||2.35|
|Janus Henderson Asian Dividend Income (GB00B6193536)||12,173.91||1.93|
|Legg Mason IF RARE Global Infrastructure Income (GB00BZ01WT03)||14,532.22||2.3|
|LF Gresham House UK Micro Cap (GB00BV9FYS80)||12,603.59||1.99|
|Lindsell Train Japanese Equity (IE00B3MSSB95)||23,545.79||3.7|
|M&G Emerging Markets Bond (GB00B4TL2D89)||16,890.85||2.67|
|Man GLG UK Income (GB00B0117D35)||13,387.29||2.12|
|MI Chelverton UK Equity Growth (GB00BP855954)||15,621.19||2.47|
|MI Chelverton UK Equity Income (GB00B1FD6467)||13246.26||2.1|
|Polar Capital UK Absolute Equity (IE00BQLDRR58)||11,231.64||1.78|
|Royal London Sterling Extra Yield Bond (IE0032571485)||12,929.24||2.05|
|Royal London Sustainable Leaders (GB00B7V23Z99)||9,268.55||1.47|
|TB Amati UK Smaller Companies (GB00B2NG4R39)||14,791.28||2.34|
|TB Evenlode Income (GB00BD0B7G86)||14,108.85||2.23|
|VT Gravis Clean Energy Income (GB00BFN4H461)||12,011.53||1.9|
|VT Gravis UK Infrastructure Income (GB00BYVB3J98)||14,627.02||2.31|
|3i Infrastructure (3IN)||14,053.22||2.22|
|Aberforth Split Level Income Trust (ASIT)||12,354.30||1.95|
|Apax Global Alpha (APAX)||13,495.17||2.13|
|BB Healthcare Trust (BBH)||15,392||2.43|
|BlackRock North American Income Trust (BRNA)||12,155.52||1.92|
|Bluefield Solar Income Fund (BSIF)||14,410.16||2.28|
|Dolphin Capital Investors (DCI)||267.12||0.04|
|Ecofin Global Utilities and Infrastructure Trust (EGL)||18,115.46||2.87|
|Fidelity Asian Values (FAS)||14,785.35||2.34|
|Impax Environmental Markets (IEM)||13,003.65||2.06|
|International Biotechnology Trust (IBT)||11,631.08||1.84|
|International Public Partnerships (INPP)||13,991.25||2.21|
|Invesco Perpetual UK Smaller Companies Investment Trust (IPU)||20,854.08||3.3|
|JPMorgan Asia Growth & Income (JAGI)||17,299.20||2.74|
|Picton Property Income (PCTN)||18,067.40||2.86|
|Primary Health Properties (PHP)||17,116.14||2.71|
|Princess Private Equity Holding (PEY)||14,795.23||2.34|
|Real Estate Credit Investments (RECI)||11,853.14||1.87|
|Rights and Issues Investment Trust (RIII)||16,791.75||2.66|
|Standard Life Private Equity Trust (SLPE)||14,206.50||2.25|
|Tritax Big Box REIT (BBOX)||13,863.46||2.19|
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:
It’s good that you are making use of tax allowances by investing the maximum amount possible each year into your Isas and withdrawing the tax-free element of your pensions.
I also like that you are well diversified across equities. But I’m not sure how far you can mitigate risk by diversifying so much across equities. By holding less volatile funds focused on areas such as defensive equities and infrastructure you are probably doing as much as you can in this respect. But it may not be enough, meaning that you may need other risk management strategies.
One option is the 10-month or 200-day average strategy, which involves selling a security when its price dips below this average. It doesn’t work if the market suffers short-term blips, but does protect against the really nasty losses of a protracted bear market.
Dennis Hall, chief executive officer of Yellowtail Financial Planning, says:
Your investment portfolios don't seem to have an overarching structure or central investment philosophy. Trying to amass as much capital as possible via income and capital appreciation doesn’t create any meaningful direction or accountability, and results in an opportunistic approach to portfolio construction. So I cannot fathom your investment choices.
With the exception of a few short bear markets, investing in equities has been a profitable exercise. Over the past decade in particular, making money wasn’t difficult as long as you avoided funds that invest in areas such as commodities, energy or Brazil. High-profile US investor Warren Buffett said that when a “rising tide lifts all boats” it’s easy to believe you have acquired some skill in investing rather than attributing your success to luck.
You hold funds run by Keith Ashworth-Lord and Nick Train, who don't buy and sell holdings very much so hold companies for several years. I’m struck by the level of thought and research that goes into each of their buying and selling decisions, and can understand their philosophies. Their performance holds up too. But that level of clarity is missing from your portfolios, which appear to have been constructed via a variety of approaches including thematic, momentum, value, income and growth.
Define and write down what your core investment philosophy is, including your criteria for buying and selling a fund. This is important because you are managing family money worth around £4.5m. A documented, robust and repeatable investment process will help you, and inform whoever subsequently manages the portfolios when you are no longer able to. On that note, do you have a Lasting Power of Attorney in place to delegate financial matters in the event that you become incapable?
Managing your portfolio to restrict downward volatility is counter-productive in the long run. Short term volatility is rarely a problem for investors with long time horizons, provided they have enough liquid assets to meet their short-term needs. Being open to volatility also means being open to opportunity. A study in 2016 showed that over the preceding decade, which included the financial crisis, the 10 most volatile funds in the Investment Association UK All Companies sector slightly outperformed the 10 least volatile funds – albeit with a greater maximum drawdown.
I like your portfolios' bias to smaller companies, but this needs patience, as does private equity where the lack of visibility can be worrying.
Although diversification is an investor's friend it can also depress performance if you invest in several funds with a similar focus. So your portfolios could benefit from some rationalisation to provide more direction and focus.
Michael Melrose, financial consultant at Alan Steel Asset Management, says:
Look at your financial and investment planning from a broad and long-term point of view.
Taking the tax-free cash from your Sipps to spend and to reinvest in your Isas, and drawing from your Isas when you have used that up, doesn’t sound right from a strategic tax planning point of view. I assume you have been drawing tax-free cash from your pensions for a few years. If you have £1.1m in your Sipps and £150,000 tax-free cash is currently still available, it suggests that £600,000 is uncrystallised and £500,000 is in potential drawdown. I assume that you have taken out some level of Fixed Protection, in which case there could be inheritance tax (IHT) benefits in allowing the pension funds to grow, rather than the Isas. You are only 68, so if you allow the pension funds to grow, when one or both of you has died, the eventual IHT charges might be lower.
If your investments are successful, you reduce the pension funds rather than the Isas and your home increases in value, your assets might incur even more IHT if the total taxable value of your assets rises above £2m after both of your deaths.
So consider accessing the Isas for income earlier than planned.
If you are looking to preserve wealth, perhaps reduce the number of funds you hold and increase the downside protection to be on the safe side because your investment portfolios are higher risk. Also consider whether your wife and/or other family members will be comfortable managing the investment portfolios in the same way as you have when these pass on to them. In our experience, those who inherit investment portfolios prefer greater simplicity.
HOW TO IMPROVE THE PORTFOLIO
Chris Dillow says:
Investment trust discounts can indicate future returns. But remember that a trust’s discount relative to its own history is what matters – not what it is relative to other trusts. You’re wise to consider private equity investment trusts as I suspect a fair chunk of future growth will come from companies that are not yet listed on stock exchanges.
However, your investments have some liquidity risk. Property and private equity companies can be hard to sell quickly at a good price, especially in a downturn. With investment trusts this risk often manifests itself in big discounts to NAV. This risk shouldn’t be a problem for longer-term investors, who could earn a premium for taking it on. Just ensure that you never have to sell such investments to raise cash quickly.
You may be holding too many active funds. Diversification reduces upside returns as well as downside losses, so if you have too many holdings there’s a danger that your portfolio performs like a tracker fund but with much higher costs. Consider whether higher-cost active funds you hold or are thinking of buying do anything that you are not getting from other funds, or could get from a cheaper passive fund.
I’m not wholly comfortable with your decision to hedge foreign currency exposure back into sterling. Sterling’s real exchange rate, which is adjusted for differences in inflation between the UK and US or eurozone, is quite low by historic standards. And this has been a good predictor of subsequent rises in the nominal exchange rate over periods of about three years.
But there is a risk that sterling’s low real exchange rate is not because it has overshot its fair value, but is due to a genuinely worse outlook for economic growth post-Brexit. Its future moves might well be driven by market assessment of our trading arrangements after the transition period. I personally wouldn’t want to bet heavily on these.
Also, if there is an equity bear market sterling might fall and magnify your equity losses. Because it is considered a risky currency, it falls when investors become more nervous, but if investors’ appetite for risk rises you might profit on sterling as well as equities. However, you are still taking on extra risk by hedging.
Michael Melrose says:
You have repositioned your investments since the general election and almost all your new holdings are in the first quartile of their fund sectors in terms of performance over the past five years, which sets off our alarm bells. When you have implemented a long-term investment strategy you should make tweaks rather than wholesale sales and purchases. And when investors choose new funds they often go for recent successes. But we would expect to find funds in portfolios that have not been in the first or second quartiles of their sectors recently, in terms of performance.
We first consider economic and business cycles, and then choose appropriate funds. After a market crash such as in 2000 or 2008 we look for recovery and or growth sectors, for example technology and small- and mid-caps. But we also protect against unexpected events with global income and cautious managed funds. We also examine each fund carefully to establish what its manager’s investment style and process is, and then select an appropriate mix of funds.
The UK looks cheap, and funds with a value investment style should bounce back after many years out of favour. But you hold too many funds, and should have different investment strategies in your Isas and Sipps. And within these accounts the core of your holdings should be what is likely to do well in the next five years.
Although emerging markets look cheap, remember that Latin America and value investments looked cheap 10 years ago, but Latin America funds have generally not made relatively strong returns over the past decade [compared with broad global emerging markets funds].