Effective Investing

by Mark Dampier

  By upping his holdings in funds that were already showing such exceptional gains, he was ensuring that his portfolio was becoming even more skewed in just one direction. It was no longer even remotely balanced. Rebalancing at the start of 2000 would have saved him a fortune. The point is that following a mechanical rebalancing discipline at regular intervals can stop you falling prey to your emotions. Investors always find it hard to sell things that have gone up a lot. They are terrified of leaving money lying on the table by selling too soon. But it is often the right thing to do. Rebalancing in that sense is a means to saving you from yourself.

  There is a downside, of course. Every time you sell some funds to buy others, you incur dealing charges, and the more often you do it, the greater the cost becomes. That was a bigger problem a few years ago, when many funds still charged you 5% upfront as a buying fee. My view is that it can be sensible to do some rebalancing of either assets or funds themselves, but I don’t think it is essential when you have more experience. Whether it should be done on a particular anniversary every year, such as January the 1st, I rather doubt. I like to look at the wider picture of what is going on in the markets and economies before binding myself to a particular date in the calendar and I suspect that once a year may actually be too frequent an interval.

  Keeping an eye on the shape of your portfolio over time is, however, obviously common sense. It is important to beware of double counting. Fifteen years ago many investors bought specialist technology funds without realising that the other funds they owned were already investing heavily in the same space. Some European equity funds, for example, had more than 50% in the tech sector. When the technology craze passed, those investors suffered a double whammy of losses.

  What this underlines is that while adding more funds to your portfolio helps to protect you, having say five funds which are all doing the same thing is a waste of time. If you own equity income funds, it makes sense to have both Artemis Income and the Marlborough Multi Cap Income, for example, as they invest in different sectors of the equity market. But it makes little sense to pair two equity income funds that are doing more or less the same thing. The same goes for bond funds. It is sensible to pair a high-yield fund alongside an investment-grade fund, but not to have two that are cut from the same cloth. Once again you have to look under the bonnet to find out what you have. A number of platforms offer so-called x-ray tools that help you to find this information out.

  Themes and sectors

  The onset of globalisation in recent years means that ensuring you have a finger in all the main types of fund is more difficult. For example, a company like Glaxo is listed in the UK, but the vast majority of its profits come from America, so which country is more important to its results? Shell, the doyen of the oil sector, operates right around the world and reports its dividends in dollars, not pounds. If you are seeking to analyse your geographical diversification, which stocks should you include where? The past few years have seen a large number of new sector and theme funds being launched. There is nothing intrinsically wrong with this, but it can easily cause you to over-concentrate your portfolio in one area of the market.

  For example, buying a fund that only invests in financial stocks may not be necessary if you already have other unit trusts with a significant weighting in financial stocks. You should weigh up carefully the make-up of your existing portfolio holdings before stuffing it with additional sector/theme funds. My experience has been that if you do buy a specialist fund and it does well over say a two to three year period, then you should consider selling it, as individual themes and sectors rarely continue to outperform indefinitely. This is the opposite of what I suggest you do with your core diversified holdings, where it is worth holding on and backing a good fund manager through occasional poor periods.

  The more specific the investment objective of a fund, and the riskier the underlying holdings, the more dramatic the movements in its price are likely to be. Two exceptional examples in recent years would be gold and Russian country funds. Take a look at this chart of the Blackrock Gold & General Fund, probably the most popular of all the specialist funds investing in gold and mining shares. For ten years after the turn of the century, the fund produced some stellar returns, albeit interrupted by a dramatic collapse during the financial crisis of 2008. By Q1 2011 investors who had bought the fund six years earlier were sitting on gains of more than 300%.

  Figure 6.7: A roller-coaster ride – the Blackrock Gold & General Fund.

  The manager is a talented individual, but even he was unable to keep performance going when the resources boom that had driven mining stocks sharply up in value for several years started to reverse. Loyal investors were caught on the hop as the fund fell in value by more than 60% in little over two years. Many lost all the gains that they had accumulated in the earlier period. (I know, as I was one of them, breaking one of my golden rules of investment: never fail to take at least some profits from your specialist funds as they go up.) Those who still hold the fund in their portfolios are now almost back to where they started, with little even in the way of dividends to show for their patience. Like the Duke of York, they have marched their money all the way up, and now they have marched it down again. Investors in Russian funds have enjoyed an almost identical ride – rapid gains leading up to a peak and then a relentless decline, as the next chart illustrates. It shows the performance of the Neptune Russia fund over the past ten years, one of the few specialist funds that invests solely in Russian companies. It clearly follows the same pattern as the mining fund, with periods of outrageously good and outrageously poor performance. The reasons are not that hard to find. The Russian stock market is relatively small for such a vast country and is completely dominated, like the Russian economy itself, by oil, gas and resources companies. You would not call Gazprom, the largest company of all on the Russian stock exchange, a model of good corporate governance, since it is scarcely credible that it would ever put the interests of shareholders ahead of those of the Kremlin.

  Figure 6.8: Another up and down experience – the Neptune Russia Fund.

  Yet as long as commodities were still every investor’s favourite investment sector, if you could stomach the various risks, you would at least have remained comfortably ahead. Since 2011, however, the trend has gone into sharp reverse. Even though the oil price remained above $100 a barrel until the middle of 2014, the Russian stock market started falling well before then – a good example of how stock markets are often forward indicators of trouble ahead. In 2014 the seizure of Crimea led to heightened fears about political stability, while the sanctions that followed naturally depressed the value of any company based in the country.

  The lesson that I take from all this is not that specialist funds should be avoided completely. If you can spot a developing trend in a specialist area, there is nothing wrong in joining the bandwagon – so long as you keep a sense of reality. Funds that shoot up very fast – much faster than the market as a whole – invariably tend to give most of the gains back on the other side. What is more, the nearer they are to their peak, the more attention they will be getting from the media and advisor community, assuring you that they are the best thing since sliced bread – a good signal that you need to start being more cautious.

  If you reach a point where a fund is up by 100% in one year, or by 200% or more over three to five years, my advice is that you should already be thinking about reducing your exposure. Don’t worry about leaving money on the table. Bank the gain and move on to something else. As Warren Buffett likes to say, “Be fearful when others are greedy. Be greedy when others are fearful”. DIY investors often seem to think that if something like gold or Russia becomes wildly expensive, the manager of a specialist fund in those areas will start to sell his holdings in favour of cash in order to wait for better opportunities ahead. But that is unfortunately not how the business works. What the managers of the funds will say is that they are being paid to own st
ocks in their specialist area and they are not mandated to do anything else. (The cynics among you might say that they have no financial incentive to do anything else – I couldn’t possibly comment.) It is always down to you to yank your money out when the going gets too good to be true. In the industry we call this kind of fund ‘sex and violence funds’: the problem is you tend to get the violence, but not the sex!

  Points to remember

  Portfolios are made up of a number of different funds.

  Funds that are currently fashionable are often the most dangerous.

  The objective is to match your risk profile. You can vary the risk in any portfolio by adding bonds or cash.

  Rebalancing can be a useful way to keep your risk at the right level.

  Adding more than one fund in each sector can reduce your risk – but not if the funds are doing exactly the same thing.

  Think about selling specialist funds that have shot up a long way very quickly.

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  14 Conservative, medium risk, adventurous, investing for children, and regular income.

  Chapter 7. How I Invest My Own Money

  Given that it is my job to help other people decide what to do with their money, it is only fair to share with you what I do with my own money. I am lucky enough to be well-paid for what I do and have access to the work of a highly-skilled research team. But if you look closely at what I do with my own finances, there is very little in principle that you could not do yourself. If there are echoes of some of the things I have said in earlier chapters, that is because I always try to do myself what I recommend to others.

  So, for example, I have for many years made full use of both the annual ISA allowance and the tax relief available on contributions into my SIPP (personal pension). The most significant investments I have outside these two tax-efficient pots of money are some holdings in venture capital trusts, which I describe in the next chapter. (They are attractive primarily because they too have tax advantages. They pay tax-free dividends, something I am looking forward to receiving when I retire.) The messages I give to others – keep it simple, stick to your principles, learn from your experiences and you won’t go far wrong – are those I try to follow myself. Don’t be afraid to ask other experienced investors or trusted colleagues for advice; they can be very helpful. I regularly ask my colleague Lee Gardhouse, for example, for his thoughts on funds I am thinking of buying or selling.

  One important disclaimer

  It is worth saying up front that one of the things that is irritating about most financial advice, whether from the industry, media or regulators, is the cosy assumption that everyone’s life proceeds in a single straightforward line, untroubled by chance, unexpected events and family or career interruptions and shocks. We all know that in reality life is never really like that. While it may have been much simpler in the days when jobs were for life, and job mobility much lower, most people’s careers and financial circumstances these days inevitably advance in stops and starts.

  I am in my late 50s and lucky to be comfortably off. There will come a time before long when I will want to start slowing down, though whether I actually retire altogether I am not sure. Like most people who work in the investment business, I am having too much fun to be sure how I would keep myself amused without the stimulus of keeping a close eye on what is going on in the markets.

  But I have not been comfortable forever – far from it. I have already described how the stock market crash in 1987 was a very tough time for me and my family financially. I was still in my early 30s and my income suffered a sharp fall when I could least afford it. Because I worked in the business, I had been smart enough to start making payments into a private pension plan, on top of the mortgage and ordinary outgoings that my wife and I had at the time. It did not take me long, however, to realise what rotten value the private pensions of those days were. They were called Section 226 schemes – and with a stupid name like that it was perhaps not a surprise that so few people were rushing to take one out.

  The charges on these schemes were astronomically high. For that reason they were very popular with life industry salesmen, who could earn a huge chunk of savers’ money as upfront commissions. In some cases they were taking as much as four years’ worth of your regular savings as a reward! If you invested a lump sum of £25,000 in a private pension, after the sales guys had taken their cut, you were several thousands of pounds down before you even started investing. Over, say, 25 years the money they took upfront could have become a whole lot more. (To give one example, £5,000 invested in the stock market in 1990 would be worth more than seven times as much today.)

  The opportunity cost, in other words, was huge. When the regulators finally forced the life companies to come clean about their charges, there was a lot of pushback from consumer groups and parliament and eventually door-to-door insurance salesmen found that their days were numbered. Don’t get me wrong. Salesmen weren’t all bad, in that they did at least get some people saving – but that saving could have produced so much bigger returns if the charges had been more reasonable. (Nor should you worry too much about the salesmen: many of them simply hung up their raincoats and set up shop as so-called independent financial advisors, where until the rules changed recently they continued to take thousands of pounds in sales commission under the guise of giving advice on products they were effectively being paid to promote. Not all financial advisors are poor and sales-driven only, but the question has always been integrity.)

  The early 1990s, when interest rates shot up, was a tough period for everyone and it was only a few years after I joined Hargreaves Lansdown that I finally became well-paid enough to start saving regularly at the rate required to build up my income requirements for later in life. Some years I was able to put quite a big chunk of what I earned as a pension contribution into my SIPP. Unfortunately, over the last few years, the limits on how much you can contribute in any given year have been sharply reduced, in part because of the government’s fears that people taking advantage of the tax breaks on pension contributions were costing them too much in lost tax revenue. For those who qualify, however, they remain a valuable incentive, as they have been for me.

  A balance of ISAs, SIPPs and others

  Having been able to make full use of both my ISA and pension allowances, I think of my portfolio as a single investment pot. The funds that I buy for each one are to a large extent the same. I have always taken the view that a good fund will do the same job wherever it is held. One difference is that I own a number of shares in my company, Hargreaves Lansdown, and as a result shares make up a bigger proportion of my ISA than my SIPP. But, as funds are my area of specialism, I don’t as a rule own a lot of individual shares.

  You can see a list of the largest investments in my SIPP on page 146. My biggest ISA holdings are shown on page 160. The similarity between my ISA and SIPP portfolios may become less marked in years to come as I gradually start to look forward to the time when I draw more from my pension fund as income, rather than continuing to try and accumulate as much capital as possible. That point will come if and when I start winding down from my job.

  That may not ultimately be my decision to make – like anyone else, the company could decide I am starting to lose my marbles and ease me out – so it is obviously prudent to slowly alter the mix of funds I own in the two different pots towards a greater reliance on income-generation. This is a natural progression for anyone who is approaching retirement age. The younger you are, the more relaxed you can afford to be about the balance between income and capital appreciation (but bear in mind that funds which pay regular and rising dividends tend also to produce higher total returns over a period of years, so they can be worth opting for even if you don’t take them as they are paid).

  Flexibility is crucial

  It is worth remembering how flexible funds can be in planning ahead in this way. I have already described the adv
antages I see in owning equity income funds, not just for their generally superior returns, but also because you don’t need to overhaul your portfolio so radically as and when your income needs change. All you have to do at that point is switch from reinvesting the regular distributions to taking them as income.

  When it comes to buying accumulation or income units, I generally prefer to opt for the income units. The main reason is that it means that I always have some new money coming in which I can invest where I currently see the best value. Sometimes a new fund launch will catch my eye. Or I may decide that there is a particular market or sector that looks particularly attractive at the time. Or I may simply want to tweak the mix of the portfolio a little bit.

  In practice my experience is that the best opportunities for new investments often come when there is a sudden or unexpected market sell-off. If the equity markets fall by 10%–15%, it is usually because there is a fair amount of bad news around. That gives you a chance to pick up some more of your favourite funds at an attractive price. Good recent examples would be the succession of market scares we have had over the future of the eurozone. By my reckoning there have been at least four euro panics in the last few years that have sent investors running for cover. In each case I have used the sell-offs to put some more money to work.