Three model portfolios for retirement income
The outlook for the rest of 2017 doesn’t appear any calmer. Political uncertainty is still at the top of the list with a string of elections across Europe, while it’s unclear what approach central banks will adopt over the coming months.
In the fifth issue of Moneywise's How to Retire In Style, we unveiled three portfolios – for £100,000, £200,000 and £400,000 pots – designed by financial gurus for those wanting consistent incomes. Six months on, we look at their performance.
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The second half of 2016 was as unpredictable as the previous six months, according to Ben Willis, head of research at Whitechurch Securities, who put together our £100,000 portfolio, primarily aimed at investors seeking income.
Sterling weakening significantly in the wake of the Brexit vote, the subsequent strong rally of the FTSE 100, and the Bank of England announcing another rate cut down to 0.25% have all been big topics.
“It’s hard to position a portfolio when markets are driven by short-term political events and ongoing central bank policy,” says Mr Willis. “Shock events such as the EU referendum result and Donald Trump’s US election win were quickly shrugged off by the markets.”
He believes this shows the importance of putting the right building blocks in place: create a diversified portfolio; investment with a medium- to long-term outlook; focus on your objective; and never compromise on the risk you can take.
“There was a diverse range of returns from the underlying funds in the portfolio, with most of the equity positions contributing a positive return, while most of the bond positions lost value over the six months,” he says.
Two very different funds were the star performers: Artemis Global Income (+12.6%) and L&G All Stocks Index Linked Gilt Index (+6.6%). “You could argue that both benefited from the reflationary environment that built up towards the end of 2016,” he suggests.
Mr Willis explains Artemis Global Income adopts a so-called “value investing” approach, which sees it favour large companies that are cheap because they are undervalued by the stock market.
“These came back into favour with investors as inflation expectations increased, which led to a more favourable growth outlook and the demand for a higher real return,” he adds.
The L&G holding, meanwhile, is a hedge for Mr Willis, who points out that the index is very long in duration, pays virtually no yield and, with demand having pushed prices up so much, it only provides any inflation proofing if held for 20 years.
“However, whenever there are inflation spikes and/or wholesale risk aversion, these assets are in demand,” he says. “As such, we hold them as a hedge against the risk and the positioning we are taking elsewhere.”
His most high-profile disappointment has been CF Woodford Equity Income fund (-2.4%), although Mr Willis notes it doesn’t hold any oil majors, miners or banks, all of which were at the vanguard of index performance over the past six months. “You also can’t ignore his impeccable long-term track record, so we’re prepared to give him ample time for the fund to start performing again,” he adds.
In recent weeks, Mr Willis has trimmed some of the bond exposure to take a position in the Invesco Perpetual Global Targeted Income fund. “This is a multi-strategy absolute return vehicle that is aiming to produce a consistent income and carefully manage risk,” he explains.
“We’re aware of the headwinds facing bond markets, and so introducing this incomeproducing, non-cyclical position should aid the overall diversification of the portfolio.”
Elsewhere, he notes that commercial property still offers relatively attractive yields, but is waiting to see how it may be affected by the Financial Conduct Authority’s decision to look into illiquid assets and open-ended funds.
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Jason Hollands, managing director at The Tilney Group, points out that positive returns were seen across equity markets – especially the overseas markets, due in large part, to the impact of sterling depreciation on these holdings.
“Fixed income was marginally positive and the UK property holdings were particularly strong as bearish sentiment in the immediate aftermath of the EU referendum subsided and the discounts on the two investment companies selected narrowed,” Mr Hollands explains.
Conversely, he says absolute return funds were the main weak spot, as was the position in physical gold which declined 5% as “bearish clouds disappeared and risk assets climbed higher” as excitement about Donald Trump’s presidency reflating the US gathered pace.
“Standout performers in terms of individual positions included the CF Morant Wright Nippon Yield fund, chosen for exposure to the Japanese market, which delivered a 17% return, in part due to exchange rate movements,” he says.
Artemis Global Income I (+15%), F&C Commercial Property Trust (+12%) and Bluefield Solar Income (+12%), which invests in alternative energy infrastructure, were other positions that enjoyed big success.
“The weakest links were two absolute returns funds, JPM Global Macro Opportunities fund (-7%) and Aviva Multi-Strategy Target Income 2 (-1%),” he says. “ETFS Physical Gold (-5%) and Royal London Corporate Bond (-1%) were down as bond prices adjusted to rising inflation expectations.”
Although returns were positive for equities, it was a tough period for many actively managed funds, chiefly those positioned too defensively after the EU referendum and the US elections.
Mr Hollands says the markets saw a shift in sentiment in the latter part of 2016 in favour of previously unloved cyclical businesses, such as mining companies. He believes that hurt the relative performance of most UK equity income funds that invest in reliable dividend payers, compared with the FTSE All Share Index.
“This included the four funds in this portfolio, all of which underperformed the broader UK market over this period,” he says. “However, the cyclical upswing in late 2016 seems to have run out of steam and I continue to have a very high conviction in these funds.”
He believes the fund’s construction shouldn’t change. “The portfolio was designed for the long term, is well diversified and has high-quality constituents with no big changes in our views on the individual funds,” he says. “The position in gold is purely an insurance policy in the event of a collapse in confidence.”
He argues that most asset classes look expensive and there has been too much euphoria about President Trump’s plans to accelerate growth. While the president may be successful, Mr Hollands says that a lot of optimism is already priced in to markets.
He also believes there’s potential for sterling to claw back some of the sharp depreciation seen last year which bolstered returns on overseas assets – with the Bank of England potentially reversing its last rate cut by the end of the year.
“This would signal a stronger pound, so I would be careful about pouring more cash into dollar assets,” he adds.
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Adrian Lowcock, investment director at fund management group Architas, is pleased that all bar one of the funds in his £400,000 portfolio have defied a tough market to deliver positive returns.
“With a concentrated portfolio of 11 funds it’s easy to see which are contributing to performance,” he says. “Having a mix of income and growth also helped protect the portfolio as investors rotated out of fixed income and bond proxies [equities with similar characteristics to bonds – delivering consistent returns with less volatility].”
The biggest challenge has been the political landscape. “Even if you got the call right, the market’s reaction was against expectations,” he says, highlighting the shift from defensive growth companies to out-of-favour value stocks which followed the election of President Trump.
“Such changes in sentiment are difficult to predict and happen so quickly they are also hard to profit from – and this is why it’s always important to have a diverse range of strategies in a portfolio,” Mr Lowcock adds.
He points out that bonds were also hit as expectations for inflation and rising interest rates caused yields to rise and prices to fall.
“The difficulty in these situations is to maintain focus and avoid trying to chase performance when markets have rallied.” Against this backdrop he is satisfied with the performance of all UK funds.
“The smaller and mid-cap nature of the PFS Chelverton UK Equity Income fund (+12.45%) helped protect it from investors selling out of the bond proxies sector, while Franklin UK Smaller Companies recovered well from the post-Brexit slump,” he says.
The Newton Real Return fund (-6.06%), however, has been the most disappointing. “It was the only fund to deliver a negative return as interest rates rebound from record low levels, hitting gilt prices,” he explains.
“This fund is supposed to offer capital protection and to lose so much value in six months is not what I would expect.”
There’s little he would change in the portfolio, apart from reducing exposure to UK equities by cutting investment in Schroder Recovery (+15.23%) and Franklin UK Smaller Companies (+14.44%) by a few percentage points each.“This is due to taking some profits after a strong run but also to provide some capital to go into real assets, which should benefit from a return of inflation,” he says.
For this, he would use an in-house fund: Architas Diversified Real Assets, which invests in a broad range of alternatives such as infrastructure, student accommodation and airplane leasing. “The yield is 3.10%, so the addition of this fund to the portfolio would boost the income generated by a small amount, and offer diversification and protection,” he adds.
Looking ahead, Mr Lowcock says that although markets are enjoying a good spell, not all sectors or asset classes are performing. “Stock selection is increasingly important and investors need to keep calm if there are any sell-offs in markets,” he says. “Having a focus on the long-term returns should help investors navigate these markets.”
The term is interchangeable with stock exchange, and is a market that deals in securities where market forces determine the price of securities traded. Stockmarket can refer to a specific exchange in a specific country (such as the London Stock Exchange) or the combined global stockmarkets as a single entity. The first stockmarket was established in Amsterdam in 1602 and the first British stock exchange was founded in 1698.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
Corporate bonds are one of the main ways companies can raise money (the other is by issuing shares) by borrowing from the markets at a fixed rate of interest (the reason why they are also known as “fixed-interest securities”), which is called the “coupon”, paid twice yearly. But the nominal value of the bond – usually £100 – can fluctuate depending on the fortunes of the company and also the economy. However it will repay the original amount on maturity.
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.
Absolute return funds
Absolute return funds aim to deliver a positive (or ‘absolute’) return every year regardless of what happens in the stockmarket. Unlike traditional funds, they can take bets on shares falling, as well as rising. This is not to say they can’t fall in value; they do. However, over the years, they should have less volatile performance than traditional funds.
A market-weighted index of the 100 biggest companies by market capitalisation listed on the London Stock Exchange. It is often referred to as “The Footsie”. The index began on 3 January 1984 with a base level of 1000; the highest value reached to date is 6950.6, on 30 December 1999. The index is “weighted” by how the movements of each of the 100 constituents affect the index, so larger companies make more of a difference to the index than smaller ones. To ensure it is a true and accurate representation of the most highly capitalised companies in the UK, just like football’s Premier League, every three months the FTSE 100 “relegates” the bottom three companies in the 100 whose market capitalisation has fallen and “promotes” to the index the three companies whose market capitalisation has grown sufficiently to warrant inclusion. Around 80% of the companies listed on the London Stock Exchange are included in the FTSE 100.