My alternatives to equities

Current portfolio

I have over 80% of my investment portfolio in equities (company shares) and only around 2% in cash and I hold the balance in bonds and property. I’m now going to explain how I arrived at that position and how that is working for me.

Yield %Capital %Income %

My journey

When I first invested in equities in 1986, I kept a large proportion of my assets in cash because that cash was my rainy-day fund – my three, six or twelve months of spending held in reserve. On average I kept 30% in cash and on average that was about half of my net salary. As I built up my equity savings, including PEP’s when they started, the proportion of my money in cash fell. As I moved home twice in the ten years after 1986 and changed jobs twice including a redundancy it was useful to have surplus cash. Also, interest rates were more generous (and exceeded dividend yields).

By the late 1990’s I began to consider my asset allocation and by coincidence I read a book, The Fortune in Your Future by David C Veeneman, that considered some model portfolios. The book explored eleven model portfolios along a so-called efficient frontier. My preference was for the “partly cloudy” portfolio that had 79% in equities, 1% in bonds, and 20% in stable values. This was described as “a portfolio for investors who want a good return and can tolerate occasional setbacks”. I chose to interpret the portfolio allocations as 80% in equities and 20% in cash.

My portfolio roughly kept to that for the next ten years with on average 22% in cash. This will have mitigated my losses in the dot come boom and bust era. When interest rates were massively reduced in 2008, I felt it was time to reduce my cash which now represented over twice my net salary. I bought more shares and then my shares rose in price so my cash position fell from about 22% in 2007 to around 12% in 2009. I held that position for the next five years.

On ending my last job at the end of 2013, I again considered my portfolio allocation. I had only 9% in cash but I took the view that I still had too much cash given the poor returns from the low interest rates in early 2014. Cash has become trash in offering no meaningful return. Its value was in providing liquidity and stable values so long as inflation remained very low. As I began to focus more on the amount of income generated by my portfolio, I decided to put more cash into equities to drive up my income. Having invested through the stock market falls of 1987, 2001-2002, and 2008 I felt that my ability to handle equity risk was sufficient to be able to hold more equities. I then moved to have over 95% in equities and less than 5% in cash during 2014.

My next move was in early 2017 when I decided to diversify for the first time into high-yield bonds and commercial property REIT’s. This was a tactic to increase again my portfolio income but also to diversify away from the pure equities of company shares. This also reflected the idea of reducing such equity exposure as you get older. Over the next three years, I built up a position of nearly 18% in these assets. About half of that was in an investment trust that held over one hundred high-yield bonds. Its objective then was “to provide investors with a high dividend yield and the potential for capital growth by investing mainly in high yielding fixed interest securities”. The accounts of the trust at that time indicated that it had 132 holdings with the biggest one being only 3.2% of the portfolio. This gave me less risk than holding an individual corporate bond or retail bond. The other half was in a commercial property REIT investment trust that held over one hundred properties. Its factsheet then said that it had a “highly diversified regional UK office and industrial portfolio” of 128 properties, comprising 974 units, and with 719 tenants. This gave me less risk than holding an individual property with an individual tenant, and didn’t require as much of a financial commitment.

I have kept those holdings since then, both in tax sheltered accounts, with their dividends being reinvested in more shares. The only change in early 2021 was to sell half of the commercial property REIT in order to buy into a rival commercial property REIT. As I’ve previously reported that new holding has since been re-rated and is now my top performer of 2021.

Selected years

DateEquity %Cash %Bonds %Property %

My recent results

Return per annum (XIRR)TotalCapitalIncome

I have reviewed the total return on these non-equity holdings for the nearly five years I have been invested in them. I have allowed for the time invested, the gain or loss in the share price, and the dividends received. I calculated an internal rate of return (XIRR using an excel spreadsheet). This gave an overall result of 6.19% per annum. There has been some decline in capital values of -1.65% per annum but the income return has been 7.72% per annum. In simpler terms the amount invested has grown in total by 25.46%, comprising 32.46% from dividends received less -7.01% from share price falls.

InvestedDividendsCapitalCurrent Value

That 6.19% total return for these assets is close to my rough calculation of 6.10% compound growth for my total portfolio from February 2017 to November 2021. So, I have matched my equity returns and exceeded the returns available on cash. There has been significant volatility so these assets have more risk than cash and maybe more risk than equities. Certainly, the bond trust and the property trust fell significantly in March 2020. I believe they have given me more diversity whilst they have increased my portfolio yield. The current yield is 7.70%.

The future

At present these holdings of bonds and property are useful as a means of raising the level of income in the portfolio in that they provide one-quarter of the income from only one-sixth of the capital. This assists me in moving some of the equity holdings from income trusts to small company growth trusts. Going forward I am likely to maintain these investments but I can envisage in the longer term reducing their position sizes, or switching them to lower yielding alternatives, as I increasingly prioritise growth over income. I don’t plan to raise my cash levels significantly unless interest rates rise significantly so that there are some returns from cash.

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