How do ‘Ready-Made’ Portfolios stack up?
One of the challenges of managing your own pension investments is to craft a portfolio that will consistently deliver the income you require, whilst at the same time avoiding a level of risk that you consider unacceptable. The two are of course mutually exclusive; the more income you want, the higher the risk you have to accept, and vice versa.
The trick is to balance the two in a way that you are comfortable with and that will deliver the income you desire. Key to this is understanding the two principal components that make up investment performance; growth and income. Growth comes from the price of the underlying assets in your portfolio that increase or drop in value, broadly in line with stock market movements and the state of the wider economy. Income on the other hand is comprised of the dividends paid out by the underlying investments held by the fund. Most large companies pay dividends to their shareholders and the amount tends to be reasonably consistent over time, as the payout is covered by the earnings of the company concerned. Historically, and for good investor confidence reasons, large companies like to keep the level of their dividends constant, or even increase them over time, meaning that dividend income from owning their shares also tends to be less volatile.
Anyone creating an investment portfolio will attempt to balance these conflicting requirements so that the resulting basket of funds or shares matches the level of risk and desired outcomes of the client. The classic example of this approach is the ‘lifestyling’ of portfolios conducted by pension providers for company and group pensions. This recognises that while you are still young and have many years of employment ahead, you can afford to take greater risk with your investments in order to build up more capital – so the pension providers create a portfolio that focuses on growth, but will by definition involve a higher degree of risk. As you approach retirement age, the provider will gradually switch the makeup of your portfolio so that it incurs less risk – the thinking being that as you get closer to retirement there is less time for your portfolio to recover from a market setback or a global financial crisis which would reduce the value of your investments.
If you choose to invest your pension pot with one of these traditional pension providers they will offer you a range of fully managed portfolios in which to invest. However, with the new pension freedoms you are able to take that pension pot and manage it yourself, creating prortfolios that precisely match your desired level of risk, growth and income. Whilst the aim of this Blog is to provide you with the information you need to take on that management yourself, I readily accept that this is quite a daunting prospect – as do the various investment platforms – which is why their experts create model portfolios that hopefully match the needs of the majority of their clients. Most of the platforms we new pensioners will use are ‘execution only’ and are not allowed to give advice, so their model portfolios are not recommendations but indications of what sort of funds one might include in a portfolio to meet certain criteria. So, for example, a platform might create an agressive growth portfilio with a high level of risk at one end of the spectrum, and a very conservative, income based portfolio at the other end. Many will fill in the gaps between these two extremes with additional portfolios with varying flavours of risk and with different criteria.
Match the model Portfolio to your desired Objectives
It therefore follows that once you have decided what level of risk you are prepared to accept and what you are trying to achieve with your investments – growth, income, capital protection or all three – you can then look at some of the model portfolios for inspiration. The names of some of the platform model portfolios were clearly created by men in suits, well versed in the art of financial gobbledegook. Others, like those from Trustnet Direct, are the model of clarity and have descriptive names that relate to the real life outcome you are seeking, like ‘School Fees Funder’ or ‘Retirement Booster’.
A quick word also on evaluating your own acceptance of risk – this is not a straight forward activity and professional advice is really useful in helping you to examine your understanding and acceptance of risk.
There are a number of ways to invest in a model portfolio. You can either invest in the funds comprising the portfolio by buying them in your direct platform; or you can ask the platform to buy the funds for you and report on them as a portfolio (e.g. the new Hargreaves Lansdown Portfolio Plus offering); or you can get some platforms,. mainly those that have an advice element to the platform, to manage the portfolio for you on a discretionary basis – meaning they will rebalance it several times a year, take all the management decisions and send you regular income or reports (e.g Tilney BestInvest’s Multi Asset Portfolios). There is a wide variety of flavours in between.
Money Observer Magazine has created a variety of model portfolios, some by their own columnists and some by external advisers. The advantage is that they report on the portfolios every Quarter on their website, so you can see precisely how they have performed. However, despite having several portfolios that mention the increasing importance of income growth to private investors, none of their reporting actually shows the income or yield received from the portfolio constituents.
We tend to focus more on fund based portfolios than equity based portfolios here at The Pensions Blog – but if you fancy checking out an equity based portfolio where the creator has his own money invested, then pop over to UKValueInvestor and check out John Kingham’s portfolio. You have to subscribe if you want all the details, but he gives you enough information on the performance and philosophy behind it to help you decide.
It’s all about Income – or should be!
This is a bit of a hobby horse of mine now I am managing my own pension (and perhaps something to campaign about in due course), but the industry needs to wake up to the fact that retirees with moderate pension pots, taking advantage of the new pension freedoms, will be looking for a regular income from their investments (not just profit). It follows that they will be expecting pension and fund providers and independent media such as Money Observer to provide them with guidance on the income they can expect. There’s no sign of that yet though, despite a valiant but so far largely ineffective campaign from Trustnet along these lines.
Charges – know what you are paying in fees
A lot of the model portfolios include, or are based on one or more of the platform’s own multi-manager funds. There are several advantages of a multi manager fund, including the access investors can gain to a huge range of funds and investments, diversifying and thereby reducing risk. The funds are also selected and actively managed by expert investment and asset allocation specialists, who have access to much better information than the private investor and, in theory at least should be able to do a better job that we can on our own.
The major disadvantage however is the high cost of choosing multi manager funds.. With a multi manager fund you are paying twice – once for the fund management costs of the constituent funds and a second time for the management of it within the multi-manager fund. Whilst the jury seems to be out on whether the benefits of a multi manager fund outweighs the extra cost, some of the charges can be scary – for example, the BestInvest Income and Growth Portfolio has a Yield of 2.4% but the ‘ongoing fund charges’ or OCF is 1.54% and the portfolio Annual Management Charge is 0.75% – so the real yield (indicative of, but not precisely correlated with the income you will receive from the income part of the ‘Income and Growth’ Portfolio) is a paltry 0.11%!!!