What Does Your Portfolio Say?
What does your portfolio say about how the money is going to be spent? It should say something, because that is what money is for. A portfolio is not there to provide you with a regular supply of pieces of paper with numbers on them.
It is a lump of money, that is going to be spent eventually.
Is it there to
The LawSkills Monthly Digest
Subscribe to our comprehensive Monthly Digest for insightful feedback on Wills, Probate, Trusts, Tax and Elderly & Vulnerable client matters
Not complicated to read | Requires no internet searching | Simply an informative pdf emailed to your inbox including practice points & tips
Subscribe now for monthly insightful feedback on key issues.
All for only £98 + VAT per year.
- Pay school fees in a few years time?
- Pay the Sainsbury’s bill next week, and for the rest of someone’s life?
- Pay the Sainsbury’s bill when someone retires in 40 years time?
The investment world is a risky place. Knowing what the money is going to pay for tells investors which risks are acceptable, and which are not. Each of the above purposes would suggest totally different portfolios.
The other investment question is, is there
- Plenty of money?
- Sufficient money?
- Not enough money but enough to make a difference?
The second set of questions tells you something about how much risk is acceptable.
As investors, Trustees frequently have the problem of multiple beneficiaries and multiple expenditures. In the case of a simple life interest trust, the portfolio determines the division of the benefits. In any event, the link between investments and liabilities is central to the investment process.
The old model of bonds for income and equities for growth, has largely gone. Following the financial crisis, equities yield more than Gilts.
Recently UK company dividends have been much more stable than share prices. According to the Barclays Capital Equity Gilt study, the biggest fall in equity dividends since World War II was 15% in 1998.
By comparison shares lost 73% of their value in the early 1970s and falls of about 50% have happened twice since then. When asset values are so volatile, depending on realising capital to provide income, is a good way to deplete any fund rapidly.
However, the current economic crisis is frequently compared to the 1930s, and in the early 1930s equity dividends fell by third, and so there are no guarantees.
In the US dividends are actually more volatile than equity prices but even there, some types of businesses are more capable of paying dividends in adverse conditions than others.
Spreading risks between different industries, countries and asset types is as important for income as it is for capital.
Where Gilts and Corporate Bonds really contribute to portfolio construction is in the predictability of the cash flows. For example Treasury 5% 2018 will pay out £2.50 every six months until maturity in 2018 when it will also return capital of £100. The investment return might not be wonderful, but you know exactly what you’re going to get, irrespective of stockmarket movements, as long as you don’t sell.
Corporate Bonds introduce solvency risk, but the equivalent shares do not have to be good investments. As long as the company stays solvent, bondholders get paid. Unfortunately some companies do go bust.
Investors in bond funds diversify the default risk, but at the cost of having no specific maturity date. However, funds in short dated bonds may be ideal where a liability has an uncertain date but is expected to arise soon.
All this has practical implications for trustees. If for example they have a life interest trust and the life tenant is reasonably healthy, wants to visit relatives and travel a great deal, they might consider a mainly equity portfolio to generate sufficient income. If equity dividends fell, the main practical effect would probably be that a holiday is delayed until the following year.
On the other hand, the life tenant might be old, frail, not expected to live very long, and the remainderman might desperately need the money. In that case the trustees’ primary concern might be ensuring that the life tenant has sufficient income for her needs, while focusing on preserving the capital against adverse market conditions, even at the expense of investment return. A short dated Gilt or bond fund might be part of the solution.
Young healthy life tenants generally become old and frail, eventually. Any portfolio needs to be capable of changing to reflect the changing needs of the beneficiaries because one size does not fit all!
No part of the above article should be considered to be investment advice. Any specific investment or types of investment mentioned are merely there for the purposes of illustrating general principles.
FREE monthly newsletter
Wills | Probate | Trusts | Tax | Elderly & Vulnerable Client
- Relevant learning and development opportunities
- News, articles and LawSkills’ services
- Communications which help you find appropriate training in your area