Three model pension portfolios
In recent months, the world has changed. The vote for Brexit has already seen interest rates in the UK cut to a fresh all-time low of just 0.25%, meaning you can forget about earning even a half- decent rate of income from cash.
The upshot of all this is that if you want your money to go further, you will need to look to the markets – and this comes with risk.
But the key to success is doing your research and understanding what you want to achieve, and fundamentally this should be securing a decent income for the rest of your life.
So in a bid to give you a good idea of how to construct a robust drawdown strategy in the current climate, we asked three experts to put together three well-diversified model portfolios, of differing value.
Always remember that taking more than the natural yield will put your capital at risk, especially if your returns cannot keep up with the size of your withdrawals and/or markets go against you. As such, it is vital to review your fund on a regular basis, at least every six months.
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Whitechurch Securities’ head of research Ben Willis has put together a £100,000 portfolio, designed primarily for an investor seeking income.
Mr Willis is looking to generate the fund’s yield from a wide variety of sources. He says: “Despite current low interest rates, the target income for such a portfolio would be around 3.8%, providing around £3,800 a year on a £100,000 investment.”
However, with such a portfolio he would also be looking to increase its capital value, above inflation over the medium to long term, although this is of course not guaranteed.
In order to reach that goal, Mr Willis has nearly half the fund, at 48%, split between UK and global equities, of which a decent portion is focusing on equity income funds – vehicles that invest in the shares of dividend- producing firms. These portfolios include the highly regarded Woodford Equity Income fund on the UK side and Artemis Global Income from an international perspective.
“Our preference for dividend-producing UK funds will come as no surprise, given that UK interest rates are likely to be lower for longer. In the uncertain UK economic climate, it is important to remember that the UK stock market generates significant overseas income, which can benefit from sterling weakness,” he explains.
“We are looking for quality businesses that can grow dividends despite the climate. The key is to find stock-pickers who can unearth these gems at reasonable valuations,” adds Mr Willis.
At present, he also particularly likes funds that invest in infrastructure companies for income seeking investors, and on this basis has added two funds focused on the asset class from First State and Lazard.
In order to balance the significant allocation to equities, he has also included 35% in bonds. Bond yields have been falling for some time, so Mr Willis has largely avoided conventional gilts and other government bonds.
He has instead focused on “selective pockets of value”, with managers that he rates highly. Strategic bonds, which have the flexibility to invest in a variety of fixed income assets are core to this play, and key holdings include the Henderson Strategic Bond and Jupiter Strategic Bond funds.
Elsewhere and given the “high level of uncertainty across traditional asset classes”, Mr Willis has looked to alternative investments, namely absolute return funds, including Aviva Multi-Strategy Income and Newton Real Return, which aim to generate positive returns irrespective of market conditions.
This year commercial property has hit some serious obstacles, with investors cashing-in their holdings to such an extent that many funds have had to suspend trading to prevent a Northern Rock-style run on assets. While Mr Willis believes there is still a case for property, his exposure is limited. His only holding is F&C Property Growth & Income, a pan-European fund which blends property shares with direct holdings.
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Tilney Bestinvest managing director Jason Hollands is behind our £200,000 portfolio, which again has the main aim of delivering income. He says that putting the portfolio together has been “a careful balancing act” between selecting investments that will generate income and provide potential growth.
He adds: “There is also an emphasis on capital preservation as we are very cautious on the market’s outlook given valuations across most asset classes are quite richly valued at the moment, yet the economic outlook is quite weak.”
As a result, the portfolio includes exposure to certain funds that offer little in the way of yield, but are defensive in nature. Absolute return funds account for 14% and there is a small allocation to physical gold, at 4%, which yields nothing but has been included to provide some “insurance in the event of deteriorating confidence in the financial system”.
As the fund stands, it should yield 3.45% – or around £6,900 a year. Some 53% has been allocated to UK and global equity funds. The UK half includes equity income plays such as Evenlode Income and Threadneedle UK Equity Income, while the global portion has exposure to Japan via CF Morant Wright Nippon Yield and infrastructure, as seen with the inclusion of Lazard Global Listed Infrastructure Equity.
Mr Hollands says: “International equity funds include a position in global infrastructure companies, which should be relatively immune to the economic cycle, as their projects are very long term in nature and a small holding in Morant Wright Nippon Yield fund: although Japan has historically been a low yielding market where companies have hoarded cash on their balance sheets, dividends are rising.”
The “decimation of yields in fixed income”, means the allocation to bond funds is much lower than he would normally include an income portfolio, and in all there is a just a 15% allocation. He says: “The three bond funds selected each have relatively flexible mandates, with some allocation to higher yielding parts of their universes, such as unrated or high yield bonds.”
Mr Hollands has injected a slug of commercial property exposure via two investment trusts – F&C Commercial Property and UK Commercial Property, which, as they are traded on the stock exchange, do not face the liquidity challenges, open-ended funds deal with. Mr Hollands believes the economic data so far might suggest fears about Brexit may have been overdone and he asserts that these portfolios have high-quality tenants with good unexpired lease profiles.
In addition, he has put a small position into Bluefield Solar Income fund, an investment trust that holds operational solar panel farms, which are underpinned by long-term contracts. It boasts a yield of 6.9%.
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Adrian Lowcock, investment director at fund management group Architas, has compiled our £400,000 fund, which is aiming to deliver income as well as capital growth. This, he admits, is a tricky undertaking as “it can be very easy to sacrifice one for the other”. However, given its make-up, the fund should deliver a yield of 2.87% or £11,476 a year.
Global and UK equities make up a decent 60% of the fund, and while 25% of this is spread across UK portfolios notably Asia and the world’s developing nations are also part of this play given the inclusion of the likes of JP Morgan Emerging Markets Income and Schroder Asian Income.
He says: “In the UK, I have combined growth and income, using funds, which provide exposure across the whole market and complement each other. Schroder Recovery for example is looking for out-of-favour and unloved stocks, which the managers think are undervalued, while the Chelverton UK Equity Income fund has a bias towards mid-sized and smaller companies.”
On the global side, he has invested in “area-specific funds” as he asserts that a portfolio of this size can allocate significant assets to each fund, so doesn’t need a one-stop-shop approach to gain global exposure. He says: “Core developed markets the US and Europe take the largest exposure, while the remaining areas provide some potential for growth and attractive dividends.”
Mr Lowcock says: “Bonds have performed well in the low interest rate environment and while we know yields can go lower the asset class does not offer any income growth – the interest is fixed, whereas equities offer the opportunity for capital growth and a growing dividend. This complements the objectives of the portfolio.”
He does not believe property funds should be written off, saying: “Rental income is generally more stable and tends to fluctuate less as tenants sign long-term contracts and rents tend to rise.” With this in mind, he has 10% invested in the Legal & General UK Property fund, which yields 3.8% a year.
To give the portfolio a buffer against potential volatility, he added Newton Real Return. He says: “The portfolio focuses on capital preservation first and invests in gilts, bonds and blue-chip shares, so there is still a decent yield produced by the fund.”
Investment trusts are companies that invest money in other companies and whose shares are listed on the London Stock Exchange. As with unit trusts, private investors buying shares in an investment trust are buying into a diversified portfolio of assets (to reduce risk), which is managed by a professional fund manager. Investment trusts differ from unit trusts in two important ways: they are listed on the stockmarket and so are owned by their shareholders and are closed-ended funds with a finite number of shares in issue. This means the share price of investment trusts might not reflect the true value of the assets in the company (known as the net asset value, or NAV) and if the NAV value of a share is £1 and the share price in the market is 90p, the trust is said to be running a discount of 10% to NAV. But this means the investor is paying 90p to gain exposure to £1 of assets. Investment trusts can also borrow money and use this money to buy investments. This is known as gearing and a geared trust is thought to be more of an investment risk than an ungeared one.
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).
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%.
The familiar name given to securities issued by the British government and issued to raise money to bridge the gap between what the government spends and what it earns in tax revenue. Back in 1997, the entire stock of outstanding gilts was £275bn; by October 2010 it had surpassed £1,000bn. Gilts are issued throughout the year by the Debt Management Office and are essentially investment bonds backed by HM Treasury & Customs and considered a very safe investment because the British government has never defaulted on its debts and this security is reflected in the UK’s AAA-rating for its debt. Gilts work in a similar way to bonds and are another variant on fixed-income securities.
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).
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.
Also referred to as the bank rate or the minimum lending rate, the Bank of England base rate is the lowest rate the Bank uses to discount bills of exchange. This affects consumers as it is used by mainstream lenders and banks as the basis for calculating interest rates on mortgages, loans and savings.
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.
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.
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.