Alan, age 55, sold his business five years ago and no longer works. He lives off the income from 22 investments he holds in a trading account. He doesn't take the income from the investments in his self-invested personal pension (Sipp) or individual savings account (Isa), but rather reinvests anything he receives. His home is worth £2m and mortgage-free.
Sipp, Isa and trading account invested in funds, cash, residential property
Fund Sipps for nephews and nieces, pay for travel, steady investment growth and income over the long term
“Most of my current investments were bought with the proceeds of the sale of my business, although I have been investing for 35 years,” says Alan. “My annual expenditure is generally well below my income, so I would not go short as a result of major dividend cuts. The only really big-ticket item I spend on is travel but have, of course, had to postpone the trips I had planned for this year.
"I have already helped my nephews and nieces to buy homes. I have also recently started a Sipp for each of them and intend to put £3,600 a year into each of these.
"I have two defined-benefit pensions with former employers which I expect, in aggregate, to pay out around £9,000 a year.
"So I don’t want high growth, but rather steady growth and income. And as most of my holdings are in what I think are solid companies, even though the overall value of my investments dropped by a third in March I was not unduly concerned. I expect further drops before markets begin to turn.
"I top up my Isa by the full allowance each year [which for the 2020-21 tax year is £20,000]. My aim is to invest for the long term and not sell any holdings. That said, before markets started falling earlier this year I considered selling my holdings in Lowland Investment Company (LWI) and City of London Investment Trust (CTY), but I had not identified suitable investments to switch into."
|Holding||Value (£)||% of the portfolio|
|Blackrock Throgmorton Trust (THRG)||361,600||4.28|
|City of London Investment Trust (CTY)||323,000||3.82|
|F&C Investment Trust (FCIT)||452,800||5.35|
|Finsbury Growth & Income Trust (FGT)||376,000||4.45|
|JPMorgan Mid Cap Investment Trust (JMF)||235,800||2.79|
|JPMorgan US Smaller Companies Investment Trust (JUSC)||222,000||2.63|
|Lowland Investment Company (LWI)||229,000||2.71|
|Mercantile Investment Trust (MRC)||345,200||4.08|
|RIT Capital Partners (RCP)||209,040||2.47|
|Schroder Oriental Income Fund (SOI)||188,500||2.23|
|Scottish Mortgage Investment Trust (SMT)||458,800||5.43|
|Scottish Oriental Smaller Companies Trust (SST)||99,300||1.17|
|TR Property Investment Trust (TRY)||252,400||2.98|
|Witan Investment Trust (WTAN)||237,900||2.81|
|Vanguard FTSE 250 UCITS ETF (VMID)||513,150||6.07|
|Vanguard FTSE All-World High Dividend Yield UCITS ETF (VHYL)||547,520||6.47|
|Vanguard FTSE Developed Asia Pacific ex Japan UCITS ETF (VAPX)||151,650||1.79|
|Vanguard FTSE Developed Europe ex UK UCITS ETF (VERX)||656,100||7.76|
|Vanguard FTSE Emerging Markets UCITS ETF (VFEM)||184,525||2.18|
|Vanguard FTSE Japan UCITS ETF (VJPN)||104,488||1.24|
|Vanguard S&P 500 UCITS ETF (VUSA)||1,003,063||11.86|
|iShares Developed Markets Property Yield UCITS ETF (IWDP)||161,600||1.91|
|3i Infrastructure (3IN)||254,500||3.01|
|Murray International Trust (MYI)||90,630||1.07|
|Tritax Big Box REIT (BBOX)||43,696||0.52|
|Vanguard FTSE Developed World UCITS ETF (VEVE)||71,718||0.85|
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:
This is a very sensible portfolio, comprising holdings in well-diversified trackers alongside some quality investment trusts.
But one concern is how you invest for income. A high yield is often a signal that there’s something wrong with a stock, for example that it offers little growth or more risk than other stocks. That is sometimes the risk of a dividend cut such as Royal Dutch Shell (RDSB) – among others – has made. You say you can absorb such cuts, but remember that they are often accompanied by capital losses as well. This shouldn’t be the case, but it’s a sign that markets are not wholly efficient.
So I would not even try to invest for income. Just have a good portfolio and create income when you need it by selling a few holdings. Doing this can be tax-efficient as sales of holdings in tax-efficient wrappers such as Isas and pensions don't incur capital gains tax (CGT). And profits from sales of holdings outside these wrappers can be offset against losses and your annual CGT allowance, which for the 2020-21 tax year is £12,300.
Your desire to hold investments forever raises issues. Even the best direct shareholdings can fall victim to creative destruction. For example, how many companies are 150 years old? Instead, you should be even more heavily invested in passive tracker funds than you already are.
But there is also a problem with this. Many of the companies that will dominate the economy in, say, 30 years’ time might not be listed today. And a number of the companies that are listed have gone ex-growth or will have trouble expanding. To mitigate this risk, consider holding some private equity investment trusts. These could give you exposure to firms that will be successful in the future and diversify the risk that ownership by dispersed shareholders might not be the most efficient corporate structure.
James Norrington, specialist writer at Investors Chronicle, says:
You’re pretty much the dream client for many wealth professionals: high value and low maintenance. The sales pitch, that I’m sure you’ve already received many times from advisers eager to take you on, probably revolved around time, risk management and tax planning.
And someone with your amount of wealth needs to seriously consider tax. Using your full Isa allowance each year is a good start, so keep investing spare income from your investments within this tax-efficient wrapper. But also speak to a well-qualified specialist on tax who could, for example, help you maximise your CGT allowance and minimise the amount of inheritance tax (IHT) your estate will incur for your beneficiaries.
Your sanguine attitude to the recent market sell-off, and realistic approach to risk and return, are precisely why you don’t need to pay an adviser 1 to 2 per cent a year to manage your investments. Before Covid-19 reared its ugly head people seemed to have forgotten that if your equity investments are to make better returns than cash, you have to endure psychologically uncomfortable periods when markets drop.
Most people don’t understand the difference between risk and loss. At the moment, you are seeing what the risk of your portfolio is with its value falling by a third. But you have not lost anything. And your funds invest in a diverse selection of companies, so it’s much less likely that one of them will become worthless.
As you don’t need to sell investments to meet financial obligations you can ride out the storm and catch all the upside when the turnaround happens.
HOW TO IMPROVE THE PORTFOLIO
Chris Dillow says:
Your investments are overweight in UK equities and this incurs two risks. The UK might suffer localised economic problems: for example, an especially hard Brexit might cause the UK economy to underperform the world economy for a long time, to the detriment of the smaller and mid-cap stocks owned by funds such as BlackRock Throgmorton Trust (THRG) and Mercantile Investment Trust (MRC).
And compared with the rest of the world, the UK equity market is underweight big tech and manufacturing companies. For many years this has been a reason for its relative underperformance, although it means that UK stocks are now relatively cheap. But we could have said that years ago, since when the market has become cheaper.
You are also a bit overweight large UK defensive equities such as Unilever (ULVR) and Diageo (DGE) because these are among City of London Investment Trust's and Finsbury Growth & Income Trust's (FGT) biggest holdings. In one sense, this is good: if any stocks are likely to be worth holding forever, it is these. But investors might have wised up to their historic error in underpricing such monopoly stocks and, if this is the case, their future returns won’t be as good as their past ones.
Alan Miller, founding partner and chief investment officer of SCM Direct, says:
Your investments are very well diversified with significant amounts invested across a wide variety of assets and regions, mainly via investment trusts and low-cost index funds. The equity exposure looks high at about 85 per cent, but this is mitigated by the fact that you can meet your daily expenditure from the income you get from unwrapped investments, and have significant cash and a long-term investment horizon.
You considered selling Lowland Investment Company and City of London Investment Trust before the recent market falls. Both of these trusts invest in the UK, but Lowland has a poor performance record, particularly recently.
As well as selling this, I suggest disposing of Tritax Big Box REIT (BBOX) and iShares Developed Markets Property Yield UCITS ETF (IWDP). The outlook for the kinds of assets they hold has deteriorated significantly due to the economic impact on the underlying valuations, liquidity and rental income of almost all property-related exposures. I would reinvest the proceeds of their and Lowland Investment Company's sales in short-term UK corporate and emerging market bonds to provide a steady income.
For exposure to UK short-term corporate bonds, options include iShares £ Corp Bond 0-5yr UCITS ETF (IS15), which has an ongoing charge of 0.2 per cent. The ETF has a yield of 2 per cent and its holdings have an average maturity of 2.7 years.
For emerging market bonds I would consider the sterling-hedged share class of UBS Bloomberg Barclays USD Emerging Markets Sovereign UCITS ETF (SBEG). It invests in emerging markets government bonds issued by countries across the world. It has a yield of about 5.9 per cent and the constituents of the index it tracks, Bloomberg Barclays Emerging Markets USD Sovereign & Agency 3% Country Capped Index hedged to GBP, have an average remaining maturity of 11.47 years. Bonds issued by any one country don't account for more than 3 per cent of the index the ETF tracks, to reduce risk.
I would also put some of the proceeds of selling those three holdings into a global value-tilted equities fund that could benefit more than many others from any recovery in world markets. Vanguard Global Value Factor UCITS ETF (VVAL) has suffered due to its exposure to value stocks, which have significantly underperformed growth stocks, such as the large technology stocks, over recent years. And the valuation gulf between these two types of stocks is the greatest it has been in 20 years.
Consider switching Vanguard S&P 500 UCITS ETF (VUSA), meanwhile, into a fund less exposed to Facebook (US:FB), Apple (US:AAPL), Amazon (US:AMZN), Netflix (US:NFLX) and Alphabet (US:GOOGL) – the so-called FAANGs. Options include iShares Edge MSCI USA Value Factor UCITS ETF (IUVF), which invests in large- and mid-cap US securities chosen according to three variables: book value to price, 12-month forward earnings to price and dividend yield.
James Norrington says:
Your asset allocation is heavily skewed to equities. That said, if you’re happy and able to sit tight in a crisis as bad as this there's little point in holding investments such as government bonds, which will probably offer negative real returns in a recovery.
This view goes against the established practices of portfolio management, and I only say it because you have no mortgages or dependents, hold plenty of cash and will get a fixed income from defined-benefit pensions. Investors should always consider their personal situation when deciding what to allocate to, although for most people investments that are no more than an insurance policy are worthwhile ways to balance their portfolios.
You have many holdings to monitor, which can be hard to dedicate enough time to, but I like that you hold both active and passive funds. However, I don't think that Vanguard FTSE 250 UCITS ETF (VMID) is a good choice because there is a lot of junk in this index. You also hold and pay the fees of active funds that aim to pick good UK-listed businesses so there is no point in owning this tracker fund.
I like your approach with active funds: you have bought some diverse investment trusts run by well-respected managers and you let them get on with it. You don’t need to pay someone to monitor this list of funds, but you should regularly review these holdings. Keep tabs on the one-, three- and five-year total returns, and pay attention to how much both your active and passive funds' performance differs from their benchmarks.
The passive funds should deliver very similar returns to the indices they track. But the active funds' returns should deviate from and outperform relevant indices. All active funds suffer spells of underperformance but, ultimately, you need to keep tabs on whether their managers are earning their relatively higher fees by investing away from the benchmark and enough of their decisions are paying off over time.