Income and growth model investment portfolios for retirement

Industry experts have built a pair of hypothetical portfolios for investors at or around retirement, but with different requirements. Tom Bailey explains the thinking behind them. 

Knowing where to start with constructing an investment portfolio to see you through retirement can be tricky. There is no one-size-fits-all solution, because different investors have different needs, levels of engagement, appetites for risk and portfolio sizes. 

However, it can be useful to take some ideas from appropriate model portfolios, so we asked financial advisers to provide them.

One financial adviser was asked to construct a model portfolio consisting of investment funds and trusts for an investor approaching retirement but still in work and, therefore, hoping to continue growing their capital without too much risk. A second adviser was tasked to provide a selection for an investor already in retirement and wanting to draw an income. 

Portfolio 1

Cautious growth-focused option

First up is an investor in his 60s who doesn't yet want to draw income. Let's call him Chris. There could be a number of reasons for Chris's preference: he might still be working, for example, or living off the tax-free lump sum element of his pension to enable the rest of it to keep growing.

According to Patrick Connolly, a chartered financial planner at Chase de Vere, Chris is likely to invest with both increasing and protecting his capital in mind. Connolly says:

"For someone in his 50s or 60s who doesn't yet need to generate income from his portfolio, the focus is likely to be on a combination of capital growth and capital protection."

At his age, assuming he is in good health, Chris needs to ensure that his pension will see him through several decades. For this reason, he will need capital growth to stay ahead of inflation, but without too much risk, for fear of suffering uncomfortable losses at this relatively late stage of building a pension. 

Connolly adds:

"Chris will want his portfolio to grow at least in line with inflation. But at the same time, he will be wary of possible losses."

To achieve this, Connolly suggests, he would be best served by equities, which have long-term growth potential.

Connolly selects L&G International Index Trust as the portfolio's core holding, accounting for 25% of the total. The fund tracks the performance of the FTSE World (ex UK) index and, as is typical of trackers, has low ongoing charges (just 0.13%). It will give investors a large exposure to the US, which accounts for half of the index tracked, and to tech giants such as Apple, Microsoft, Alphabet (Google) and Amazon.

Connolly includes another low-cost tracker, HSBC FTSE All-Share Index, which constitutes 20% of the portfolio. He says:

"UK investors will typically want exposure to their home market, and this fund provides this by tracking the performance of the FTSE All-Share index."

The tracker also has a low ongoing charge of just 0.16%. With the fund's largest holdings being those with the highest market cap among UK-listed stocks, Chris gains exposure to stalwarts such as HSBC, Royal Dutch Shell, BP and British American Tobacco, among other companies.

As an actively managed equity fund offering prospects of out-performance, Liontrust Special Situations is recommended by Connolly as a 15% allocation. The fund invests in a blend of large-, mid- and small-cap UK-listed companies. Connolly is a fan of the fund's investment approach, which is termed the "economic advantage process". He explains: "It uses robust risk controls and adopts a defensive style. The fund tends to perform especially well when stockmarkets are volatile."

Alongside these equities, however, Chris should hold other asset classes, including fixed interest and property, says Connolly. These will "provide some protection when stockmarkets fall".

To provide this diversification, he gives Royal London Short Duration Global High Yield an allocation of 10%. "This fund invests predominantly in short-maturity high-yield bonds and is managed by an experienced team that typically takes a conservative approach to running money," he says.

"It focuses on a small segment of the market, but this is an area that can offer a disproportionate level of income, currently of 5.5%, relative to the risk and level of volatility."

He gives M&G Property Portfolio a 15% weighting. By investing in commercial property, the fund should be able to "provide additional diversification and consistent returns within an investment portfolio." He adds that at the same time, "the fund is more diversified than many other property funds, having a lower weighting in London and the South East".

Portfolio 2

Maximum income choice

Our other investor, Caroline, is slightly older and has retired. She is now reliant on her financial capital to generate income, as she no longer works and has not yet reached the state pension age.

That's why Caroline wants to draw a comfortable income to live on and is aiming for a yield of around 4%. This entails opting for funds and trusts with higher yields, rather than those offering strong capital growth. 

However, she wants to achieve this with an element of growth and she would like to avoid putting too much capital at risk, as this could hurt her ability to keep drawing income in future. In other words, she wants her income to be sustainable.

Charlie Lloyd, investment manager at wealth manager Skerritts, offers a portfolio composed of six funds for an investor such as Caroline.

To help secure high income, Lloyd chooses two high-yielding funds, each comprising 15% of the portfolio. First is Schroder High Yield Opportunities, yielding a generous 6.23%. It's the highest-yielding fund in the portfolio. 

Lloyd says: "Its investment process involves identifying credit themes in order to deliver consistent alpha." This entails investing in slightly riskier assets than the other funds in Lloyd's portfolio, with 80% of this fund invested in sub-investment-grade bonds. "The fund is top quartile over one, three and five years in the IA sterling high-yield sector," says Lloyd.

Lloyd's next choice is the TwentyFour Income, which yields an attractive 5.85%. As a closed-ended investment trust, it specialises in investing in asset-backed securities, a highly illiquid part of the fixed income universe. This, says Lloyd, "provides investors with access to attractive yields and floating-rate coupons, which should rise with interest rates". He notes that the trust's management team "is highly experienced in this niche sub-sector of the fixed-income market".

Lloyd's third selection is Kames Diversified Monthly Capital, which comprises 20% of the portfolio. It is slightly less racy than his other fund choices, so it should provide Caroline with both reliable income and stability. The fund is seen as less risky and volatile than some because of its more diverse investment universe, which "includes investment-grade and high-yield bonds, UK and global equities, listed property and specialist income (listed infrastructure, asset leasing and renewables)".

Also seen as a less volatile holding is Slater Income, which makes up 20% of the portfolio. This fund, says Lloyd, has both a consistent track record and an attractive 4.3% yield, its focus being investment in dividend-paying equities. Lloyd says: "We like the fund’s bottom-up stock-picking approach."

Moreover, Slater Income is quite different from other UK equity income funds. He adds: "The manager is market-cap and sector-agnostic. The size of the fund means that small cap, Alternative Investment Market and micro-cap stocks can be considered." Importantly though, "relative to the peer group, the fund tends to exhibit lower levels of volatility, together with a higher yield."

Asia has not historically been seen as an arena that income investors would typically venture into. However, Lloyd stresses that Caroline should not overlook the region.

Liontrust Asia Income accounts for 10% of Lloyd's portfolio. It yields 4.55% and helps add diversification for our investor. Lloyd adds:

"The Liontrust Asia Income fund benefits from having a wide investment universe, most of which is set to benefit from long-term structural growth opportunities across Asia such as investments in infrastructure and rising incomes."

Finally, Lloyd adds Artemis Global Income, which has a 20% weighting. With a yield of just 2.89%, this fund will contribute much less income than the portfolio's other funds.

The fund generally avoids the traditional mega-cap income stalwarts, preferring instead to focus on large- and mid-cap companies.

"The portfolio contains a blend of low-yielding, high-dividend growth companies and traditional value names where dividend growth is low but risk is also low," says Lloyd.

He points out that the lower yield on Artemis Global Income is offset by the higher yields on offer from the other funds in the portfolio. Artemis should provide Caroline with some exposure to growth stocks, helping to ensure that income from the portfolio is sustainable.

"We like the fact that the manager doesn't simply chase yield and considers this as a vehicle for providing an attractive total return over the long term," Lloyd says.

This is an extract from an article originally published in our sister magazine Money Observer. Click here to subscribe.

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