Collectives Income Portfolio - Consolidation & Update

This started off in 2013 as my investment trust income portfolio. Over the past year or so, it has morphed into a collectives portfolio as its scope broadens to include my low cost index funds.

Merger with Individual Shares Portfolio

In April, following the sale of Unilever, my individual shares reduced to just 8 holdings. In the past week, I decided to dispose of Sky following an assessment of prospects after the full year results were announced. With the number now standing at 7 shares, I have therefore amalgamated the two portfolios.

The starting capital for the shares portfolio was £36,000 and the starting capital for this portfolio was £28,000 - a combined total therefore of £64,000.

A couple of the Vanguard funds were held in both portfolios and the units for each have therefore been combined -

Vanguard LifeStrategy 124.46 (shares portfolio) + 43.60 = 168.06

Vanguard UK Equity Income  50.0 (shares portfolio) + 14.70 = 64.70

I last updated on my collectives portfolio at the end 2015.

Although this is demonstration income portfolio, it largely mirrors my own holdings..

The dividends for 2015 of £1,280 were used to top up my holding in the Vanguard UK Equity Income fund adding a further 8.1 units.

Performance

There is no doubt the start of the year has been very volatile, not to mention the past few weeks post Brexit! The dramatic fall in the value of the pound gave a boost to my global equity ETFs and as I need to rebalance my personal portfolio following the redemption of my Coventry PIBS, I have decided to sell my 2 Vanguard ETFs as I had not been overly impressed with performance. Over the 3 years to June, VHYL had returned 4% p.a compared to 8.6% from my Vanguard LS fund. In the past month post Brexit, it has received a boost from the fall in sterling.

These transactions will therefore be reflected in the demonstration portfolio :

63 shares in VHYL @ £36 less sale costs gives £2,258 and,

270 shares in VAPX @ £15.50 gives £4,175 after sale costs

The proceeds together with the sale proceeds from Sky are currently in cash and to be reinvested at some point.

So, how have the various investments fared over the past few months and are my investment trusts adding additional value compared against my Vanguard trackers? In June I compared performance of a basket of 12 investment trusts -v- index funds over the past 5 years and which showed the trusts had the edge.

With the Vanguard High Yield disposal, my benchmark against which I will measure performance will be the two remaining Vanguard trackers -

1. UK Equity Income fund, and
2. LifeStrategy 60 (acc) index fund.

Total returns including income over the past 7 months are 1. 5.8% and 2. 12.8%.  Therefore, taking an average, the benchmark figure against which to assess the portfolio is 9.3%

The managed trusts have provided mixed returns. Leading the gainers unsurprisingly are Blackrock Commodities Income +32% closely followed by Murray International +31% and which is showing signs of recovery after a couple of poor years, however these trusts form only a small percentage of the portfolio and so will have less impact on total returns. My largest holding, Edinburgh has been fairly flat year to date however there have been solid contributions from  Finsbury Growth and Murray Income both +10%. The only trust in the red for the year to-date is Aberforth Smaller -14%.

MYI -v- FTSE A/S Index Year to Date
(click to enlarge)

The portfolio has therefore made a little progress since 1st January. The value of the collectives portfolio at the start of 2016 was £35,129 and the shares portfolio was £40,425 - combined therefore = £75,554 compared to the combined current value of £80,837 - a rise of £5,283 and total return of 7.0%. The slight drag on performance has been the remaining individual shares which are collectively showing a negative total return of -3.5% (laggards include Next -25%, L&G -15% and Berkeley -18%).

The total return for the FTSE All Share index year to date is 8.45%.

Income

As I continue to depend on the returns from my investments to pay the bills and put food on the table - at least for the next 2 years when the state pension will kick in, the objective of the portfolio is to produce a dependable income. Of course, I hope the portfolio will continue to generate good returns for many more years but after 2018 I will not be dependent upon it to cover essential expenditure!

As a large proportion, ~1/3rd of my portfolio comprises Vanguard LS60 (acc), the aim is a positive total return rather than focusing on just the natural income. This will be the first full year that I have the option of selling units from my Vanguard LifeStrategy index fund.

In July following the fall in sterling and the corresponding boost to the VLS fund price, I took the opportunity to sell 13.46 units @ £155.32 to give £2,078 after sale costs and representing 8% of my total holding. This will provide my 4% income requirement for this year and the additional 4% has been added to my 10% cash buffer.

Capital appreciation is always welcome but will largely follow the ups and downs of the general stock market. I have therefore put in place a cash buffer equivalent to 10% of the value of my VLS fund to cover bear market periods when returns are flat or negative. The cash is held in my Coventry BS accounts which has interest of 1.5% so my buffer has now increased to 14.15%.

Here is the combined portfolio

(click to enlarge)

Good Enough

In my younger days, I was foolish enough to believe I could beat the market. In more recent times, I am slowly learning to be comfortable with ‘good enough’. A strategy where 'average' is better than average! I’m now more globally diversified - not perfect but for now, good enough. I am edging slowly away from the rollercoaster of individual shares and entering the relative calm waters of the 60/40 Lifestrategy option. Over the coming decade, I am thinking of a steady 5% or 6% return on average (after inflation) - that will do for me.

The average annualised return after 3.7 years is ~7.1% - so far, so good.

Low Cost Index Funds - Updated

Over the past few weeks, I have been reviewing some of my earlier posts in the ‘basics’ section of the blog. Many were written in 2013 and may therefore need to be updated and expanded. This week I will take the opportunity to have another look at index funds.

For the greater part of my investing journey, I have used a combination of individual shares and investment trusts. However, I did hold a FTSE all share index PEP directly with Legal & General as far back as 1995 following some research supporting the benefits of low cost investing.

I have long been aware of the importance of keeping costs to a minimum and so my investing strategy in the earlier years was largely via the lower cost options of individual shares and investment trusts rather than the traditional unit trust funds.

More recently, I have returned more of my portfolio toward index funds following a review of strategy in early 2015.

Low Cost

As investors, we cannot control the direction of the markets but we do have a big say in what we pay for our investments and the platform we select to hold them. There is a wide choice of investment funds and trusts - some are relatively expensive, others are very low cost.

The more expensive funds are generally managed and offer to provide a better return than the market. The least expensive funds are nearly all index trackers which offer to match the index (before costs).

To get the best returns from investments it will therefore be necessary to either pay for the higher charging managed funds which can consistently out-perform the market over the longer periods or settle for holding index funds which aim to match the market in order to keep costs as low as possible.

What you certainly want to avoid is expensive managed funds which underperform the market.

One of the big reasons most managers fail to beat their benchmark consistently is the effect of fund charges - depending upon the rate of portfolio turnover which involve transaction costs - typically around 2% or even 3% every year which is a big drag on performance. Whether the manager is good, bad or indifferent, the funds all seem to charge the same ongoing charges.

So, you have maybe a 10% chance of selecting a fund that can deliver a decent return or you can choose a low cost tracker with a 100% chance of matching the index (tracking error aside).

As Charlie Munger pointed out, Berkshire Hathaway shareholders have been well rewarded over the company's investment journey. There will always be a small set of managers who will outperform market returns. The challenge is finding them, and that, as Munger told the annual meeting, 'is like trying to find a needle in a haystack.'

Better, then, to buy the haystack!

Unless you are confident a managed fund can make a difference and add value for the additional charges, for my money, most small investors will be better served over the longer term by low cost index funds.

Also, beware of the actively managed funds that are little more than closet trackers but charge you up to 15x the cost of a tracker for the privilege.

Trackers do not need to research companies, they do not need to pay for star managers and there is much less portfolio turnover compared to the average managed fund. Therefore the total charges for many of the lower cost trackers from the likes of Vanguard and BlackRock will generally be below the 0.25% mark - this could easily be 1% less than many of the managed funds which are heavily advertised in the financial media when you take into account the hidden extra costs such as portfolio turnover transaction costs which are not included in the headline ongoing charges and which could easily add an additional 0.5% to the total cost of ownership.

Index Tracker

Passive investing in tracker funds or ETFs will simply track a market, and charges will be far less in comparison. The funds are essentially run by computer and will buy all of the assets in a particular index, or the majority, to give you a return that reflects how the market is performing.

The index fund tries to match the index it follows or tracks as closely as possible. There are many  trackers to cover any index you may desire - some common ones will be the FTSE 100, the FTSE All Share, the S&P 500 (USA), FTSE All World (ex UK), and Emerging Markets.

Passive Index -v- Actively Managed Funds

A passive approach frees investors from the task of fund selection and eliminates manager risk. This means that basically their returns will be largely determined by asset allocation combined with the costs of the fund selected to track the required sector of the market.

As Tim Hale points out in ‘Smarter Investing’ - we all like to think we are a better than average driver, but not everyone can be better than average. Human nature drives us to compete with others, to succeed, and to be better than average. Investors try to get a better than average return and often select funds which promise to provide this.

However, the markets are very efficient. All the empirical evidence over decades shows that beating the market consistently after costs through skill is very difficult. The fund managers who can do this are rare and are very difficult to identify in advance.

It is a mathematical certainty that the market will beat the average fund manager after costs.

The Nobel Prize-winning economist William Sharp explained in his 1991 paper, "The Arithmetic of Active Management", the investing community is divided into two — active investors and passive investors.

Before costs, the return on the average actively managed pound will equal the return on the average passively managed pound. After costs, however, the return on the average actively managed pound must be less than the return on the average passively managed pound. Therefore, the average active investor must - no ifs, buts or maybes - underperform the average passive investor.

This isn’t a theory; it’s mathematical fact. To quote Professor Sharpe: “These assertions will hold for any time period. Moreover, they depend only on the laws of addition, subtraction, multiplication and division. Nothing else is required.”

Of course, over 1, 2 or even 3 years a fair proportion of managed funds will out-perform the benchmark index - some of this will be down to the skill of the manager allocating his/her portfolio towards the right sectors or avoiding the underperforming sectors. But some will be just the product of pure luck.

However, luck will run out eventually and over the longer periods, say 5 years +, most studies are fairly clear - more low cost tracker will out-perform the average managed fund.

Of course, there will always be the handful of star managers who can consistently produce good returns - the likes of Neil Woodford immediately springs to mind, Nick Train of Finsbury Growth & Income trust is another - however it takes several years for a new manager to build a track record and then, for the average punter, your chances of finding such a manager at the start of your investing journey are very slim.

To quote The Pensions Institute, which has conducted one of the most comprehensive studies of UK funds in recent years, the vast majority of UK fund managers are “genuinely unskilled”, and even those very few managers who do beat the market consistently “extract the whole of this superior performance for themselves via their fees, leaving nothing for investors”.

(Thanks to TEBI for the above links)

According to a recent study from Dalbar, (summarised here) the average small investor has not done so well over the 20 yr period to 2015. Their annualised average return was just 2.1% p.a. compared to 8.2% p.a. from equities and 5.3% p.a. from bonds. These studies are based on the US market but there is no reason to think the figures would be much different in the UK.

This 6% difference each year, possibly 5.5% taking costs into account, between what the investor could have achieved from the market compared to what the average investor actually achieved is called the ‘behaviour gap’.

A big reason why individuals underperform the market is the simple fact that we are human and have emotions - greed, fear - and Mr Market is an expert in exploiting our anxieties. It not easy to stay the course over 10, 20 or 30 years - not only do you have volatile markets but you also have the emotional and irrational you which manifests itself in many ways - chopping and changing your plans, chasing last years best performing fund/sector, buying high and selling low...

Here’s a useful graphic (pdf) from BlackRock which illustrates the point.

Charlie Ellis ‘Winning the Loser’s Game’
"The hardest work in investing is not intellectual, its emotional. Being rational in an emotional environment is not easy. The hardest work is not figuring out the best investment policy; its sustaining a long term focus at market highs or market lows and remaining committed to a sound investment policy. Its hard especially when Mr Market always tries to trick you into making changes".

Local or Global

Many small investors in the UK will usually hold mainly investments listed on the London exchange - typically shares, funds or investment trusts.

However, the UK market makes up less than 10% of the global market. Why limit your investments to a small sector of the global marketplace when it is just as easy to purchase the whole market?

Of course we all feel more comfortable with what is familiar and many small investors believe they understand their home market.

They are also afraid of currency exchange fluctuations. For example, following the unexpected Brexit referendum result in June, the value of sterling fell dramatically by ~ 12% in just 48 hours.

Most investors understand the principle of reducing risk by diversifying. Holding 20 shares spreads the risk compared to holding 2 or 3 shares. Likewise holding and investment trust or fund which may hold over 100 shares reduces risk even further.

The next logical step would be to hold shares from many different markets all around the globe rather than hold all your eggs in one basket - the UK.

As a general rule, for me, the lower cost funds - active or passive, will usually provide the better returns compared to the higher cost funds over time. For a simple, no frills buy-and-forget approach, I believe most investors will benefit from a low cost, globally diverse and balanced index fund.

Platform Charges for holding low cost trackers

One final consideration is the question of where to hold your low cost tracker fund. To some extent, it will be counter productive to focus on low fund costs unless you also aim for low platform costs - these two elements should be considered in tandem.

It can be a little confusing trying to work out the most cost effective way to construct your passive portfolio. Some brokers charge an annual percentage fee based on the value of your holdings and others charge a set fee regardless of how much you may have invested.

The charges for holding ETFs may differ from the charges for holding funds. With some brokers there is no charge for dealing in funds which is good if you are building your portfolio via monthly subscriptions rather than a one-off lump sum.

Depending on the size of your investments and how many trackers you may wish to hold may determine the better broker for your particular needs. It will also vary if you want a mixture of funds, shares and ETFs for example and whether you have an ISA or SIPP.

You will need to investigate which is the most cost efficient way to invest, otherwise your savings on costs could be cancelled out by platform/broker charges.

I have covered many of these aspects in my article ‘Selecting Your Online DIY Broker’. You can cross reference your selections using the excellent comparison table on Monevator.

So, low cost trackers could be a very good choice for many small investors - legendary US investor Warren Buffett says "A low-cost index tracker is going to beat a majority of the amateur-managed money or professionally managed money." - who am I to disagree!

As ever, slow & steady steps…..

Sale of Capital to Provide Income - Update

In early 2015, I began the process of reviewing my investment strategy and concluded that I would make a shift away from individual shares and some managed investment trusts in favour of more index funds. I was particularly drawn to the simplicity and balance of the Vanguard LifeStrategy option. This one-stop solution formed the central theme to my latest book ‘DIY Simple Investing’.

My Vanguard FTSE Equity Income pays a reasonable income however I do not want too much exposure to the UK equity market, therefore an increasing proportion of my portfolio has been reinvested in the VLS funds which are globally diversified.

However, whereas the yield on my UK Equity Income fund is around 4.5%, the natural yield on the VLS fund is currently only around 1.3%. The plan was therefore to sell off some units from the accumulation version of my fund to provide ‘income’.

It would not be viable to sell units on a monthly or quarterly basis due to the dealing costs involved - currently £12.50 per sale transaction with my Halifax Share Deal ISA. I therefore plan to sell down capital units from VLS just once per year.

There is also the question of what to do about the years when there is little or no capital growth to cover the 4% sell down or even years when there is a reduction in the capital value.

The Plan for Selling Capital

The LifeStrategy funds have been going for just over 5 years. The average total return for the VLS 60 fund since launch has been 8.2% p.a. so at first glance you would think it would not be a problem to sell down 4% of units each year to use as income.

However, whilst the past 5 years have been reasonably positive for both equities and bonds, I am expecting the longer term average to come down to nearer 6% p.a.

Also the 8% is averaged out over the five years. Looking at each year separately, the rolling 12m returns have been:

To June 2012  3.36%

To June 2013 12.05%

To June 2014   7.98%

To June 2015   7.28%, and

To June 2016 10.55%

Total return for the current year-to-date is 12% - much of this is due to a recent surge and the result of the falling value of sterling post the Brexit result.

I have been viewing Vanguards simulated asset class risk tool for the 31 yr period 1984 to 2015 and using a 60/40 equity/bond allocation. Over this longer period the average return has been 9.5%. There have been just 5 years when returns were negative and 26 yrs when returns have been positive.

The plan will therefore need to be flexible enough  to avoid needing to sell capital when total return for the year is flat or negative.

I have therefore put in place a cash buffer - an instant access building society account - which holds the  income I would require for at least three years - so a minimum of 10% of the VLS fund value. This should provide a sufficient buffer and enable me to draw 3.5% income for 3 yrs without selling any units in my index fund.

During the positive years I will rebuild any shortfall in the buffer account to bring it back to the 10% min. and when this is restored I will simply sell 4% of the value of my VLS fund for income. Obviously, should there be a run of consecutive returns above say 5%, I will have the option to build up the buffer account to a higher percentage, take more ‘income’ or leave the excess returns invested within the VLS fund.

My First Full Year

Fortunately, the returns from my VLS fund has been positive. Last month the return was just 4% but after the recent fall in sterling - currently $1.30, the value of the fund has increased by 15% over the past year.

Of course, this inflated value will fall back should the GBP rally against the US dollar. In view of the unexpected windfall, I have this week sold 8% of my units - sufficient for 2 years income. The additional 4% will be added to my cash buffer which now stands at 14.15% including the accumulated interest over the past 12 months.

The VLS 60 fund currently stands at an all time high of £155.  Back as recently as February, the fund was in negative territory at just £131 and at this point I was thinking I would need to use my cash buffer in my first year. Just goes to show how fickle the markets can be and how quickly and dramatically things can turn from negative to positive - just like life I guess!

For most of my investing career I have taken the natural yield from my shares and investment trusts - and for income seekers this can be a very good strategy. However it can create blindspots as you tend to filter options according to yield which obviously would rule out the likes of Vanguard Lifestrategy funds and many other perfectly sound investment opportunities.

I imagine most investors would make use of the LifeStrategy funds during the build stage of their investing career - usually via monthly DD on auto with their broker but I hope this will demonstrate it can also be an option during later years when the emphasis may shift towards preservation of capital and generating income.

So far,so good.

Vanguard LifeStrategy - 5 Year Performance

I had the Vanguard LifeStrategy Fund on my watch list as a possible option for my portfolio as far back as 2013 but as I was primarily investing for income - mainly via individual shares and investment trusts and looking for natural yield, I did not quite appreciate its full potential until early in 2015 when I was researching material for my book 'DIY Simple Investing'.

Investing is all about the long term for the best probability of a good result. Investors therefore need a sound strategy which will provide them with every chance of lasting the course or ‘staying in the game’.

It is just over one year since I purchased VLS 60 for the first time. This represented a shift in strategy on several fronts -

A move to funds rather than shares and/or investment trusts,

A move towards passive index rather than actively managed, and

A move to selling units to provide ‘income’ rather than taking the natural yield

The LifeStrategy range of funds were launched on 23rd June 2011 and therefore now have a 5 year performance which can be compared to other funds.

Last week, I had a brief look at Trustnet’s Multi manager & Mixed Asset tables to compare the performance over the past 5 years since launch.

I was pleasantly surprised to see that the Lifestrategy range all performed well compared to other funds in the same sector. In fact the LS20 was the #1 fund out of 146 funds listed in the 0 - 35% equity section and all funds were in the top 10%.

Here is a brief table listing the 5 yr performance of each fund and I have included a couple of other Vanguard funds and also a selection of my investment trusts by way of comparison. (The figures for the LS returns are taken from the Vanguard site). I must say I was a little surprised to note how well the UK government bonds have done in recent years.

(click to enlarge)

Of course, five years is not such a long time over which to draw firm conclusions but at the same time, I think it is probably long enough to give me confidence to suggest my change of strategy last year is looking like a sensible move.

For me, and I am sure many other small investors, the appeal of the VLS strategy is its simplicity combined with low volatility compared to pure equities. At the same time it offers a good total returns for the level of risk involved compared to other strategies.

I intend to reallocate further investments between the VLS60 and possibly VLS40 over the coming year.

Half Year Portfolio Review

Following on from my end of 2015 review, I have just reviewed my actual investment portfolios - sipp drawdown and ISA - for the past 6m to the end of  June. I must say it’s good to get back to more familiar territory after the political upheaval of the past week or so.

Naturally, the period has been dominated by the political agenda and referendum campaign culminating last week in the momentous decision of the UK voting to leave and followed by the prime minister announcing a decision to step down in the Autumn.

As ever, the markets have been up and down…and back up - as unpredictable as usual!

The Markets

On the markets, the FTSE 100 started the year at 6,242.

The first couple of months were very volatile with the FTSE slumping to 5,537 by mid February, later recovering to 6,400 by April. We then saw further weakness in the run-up to the EU referendum however a surprise outcome for ’leave’ sent global markets and our currency into a tailspin last Friday/Monday followed by a rapid recovery of the FTSE in the past few days. Maybe the markets are not overly concerned about the Brexit situation?

Whilst equities have bounced back, the pound is languishing around the $1.32 mark having risen to $1.50 on election night.

The index ended the 6m period at 6,504, the highest point of the half year - a gain of  4.2% - if we factor in say 1.8% for dividends paid, this will give a  figure of 6.0% total return for the period.

Of course, the UK listed market makes up less than 10% of the global market place so focussing on just the FTSE 100 for example can give a distorted picture.

Post Brexit, the value of the pound has fallen ~10% against the dollar and this has had an impact on the price of global funds and commodity related equities. Gilt yield have fallen and the Bank of England has signalled that interest rates will need to come down and there will be a further round of QE. This will not be good for savers.

The total return on world equity markets in GBP terms for the 6m to end June was 10.2%.


Shares

Following the sale of Unilever in April, my portfolio is reduced to just 8 individual shares.

A few have seen double digit gains since January - Tesco, Amec Foster and BHP Billiton and others have been adversely affected post Brexit - Berkeley, Next and Legal & General are all down over 20%. I suspect the sale of some of these remaining shares may have to be put on hold awaiting a recovery of the prices.

The total return from this sector was a disappointing -8.0% which includes dividends received of 1.8%


Investment Trusts

Most have gained quite a bit of momentum in the past week or two - the better performances have been provided by the trusts which have under performed over the previous year - Murray International is up 23% and Blackrock Commodities up 25%.

After a stellar performance over the previous 3 years, my smaller companies specialist, Aberforth has lost ground over the period and is down -22%

Share price total return from my basket of trusts has been 2.3%.

Index Funds

My global index funds and ETFs have put in a solid half year and were boosted over the past week by the fall in the pound against the dollar.

6m chart VLS 60 -v- FTSE 100
(click to enlarge)

My Vanguard LifeStrategy60 which was purchased in my new ISA with Halifax Share Dealing has also benefited from a strong rise in the price of government bonds. This is now my largest holding and has seen a gain of 9% over the 6 months period and ~5% over the past week.

The total return for my index funds has been 8.2%.


Fixed Interest

As ever, the PIBS and fixed interest sector has provided a steady and predictable income of 3.4% however capital values have declined by -1.0% leaving a total return of just 2.4% for the half-year.

My long standing holding in Coventry BS PIBS which were held in both ISA and SIPP have just been redeemed and the proceeds are currently in cash awaiting a decision on where to reinvest - probably Vanguard LifeStrategy however, with the weakness of sterling, I may hold off for a while.

I will need to review my equity/bond allocation as my equity weighting is currently well over 60% following the redemption of the PIBS.


The Combined Portfolio

The returns have been boosted by my global index funds following the fall in the value of the pound. My shares have not fared so well however, as these now represent a smaller percentage of my portfolio the impact on the combined portfolio is not so marked.

Total return for the entire portfolio of shares, investment trusts, index funds and fixed income is 3.2% which includes income of 2.4%. Since 2008, I have had positive returns from my investments and I am hoping this will be another good year however I am expecting a downturn at some point - maybe later this year or next, I don’t really know.

I am hoping my revised strategy and the move to the likes of VLS will help to cushion the inevitable reversion and help me to ride out the volatility.

As ever, I would be interested to hear how others have done over the past 6 months - feel free to leave a comment if you keep track of your portfolio.