Thursday, 15 March 2007

Remodeling a UK Equities Portfolio

For the past week, I've been pre-occupied in reviewing a UK relative's investments and it is a familiar story. This person is not at all interested in managing investments day to day but does want to save money in the long term. The result has been a hodge-podge of assets that are inefficient and poorly diversified despite owning a number of different funds. The chart on the left, taken from Trustnet, shows the various holdings. Despite the variety of names, all are essentially composed of UK equities and when one delves into the funds, one discovers the same major companies such as BP, HSBC, Royal Dutch Shell, and Barclays. The funds display the familiar under-performance relative to the index, the FTSE in this case, as four out of eight failed to beat the FTSE All Share gain of 44.3% over the past five years. For comparison, I added into the chart an index tracking fund - the M&G Index Tracker A Accumulation. As is typical of index funds, the M&G tracker also under-performs the index, gaining only 40.6% over the five years.

One thing that has surprised and disappointed me is the small number of Exchange Traded Funds available in the UK. iShares offers only a FTSE 100 (the 100 largest companies) and a FTSE 250 (the next largest companies after the 100) ETF but no FTSE All Shares tracker at all. Perhaps that is because the iShares ETFs are registered in Ireland and so do not qualify for dividends tax exemption when held within the tax-free ISA (similar to RRSP in Canada). That gap led me to search among the regular funds (called OEICs in the UK) for index trackers such as M&G's. Their management fees and expenses are thankfully not too high, as one would hope: M&G's comes in at 0.3% annually. It is interesting to note the uniform 1.5% management fee applied by all the other OEIC funds, no doubt as the result of adhering to the FSA's Stakeholder program whose aim is to ensure fair conditions for fund investors. In addition, the above returns do not account for the initial charge or front end load on the OEICs that vary from 4% to as much as 6.25%. To put it another way, making up the initial lower amount invested takes about five years at 1% return more per year. Can the winning funds continue to out-do the market or is it likely they will revert to the mean? All this is to say that I've suggested getting out of OEIC into market tracking funds.

The other major change is to suggest to my relative to take advantage of the ISA program under which one can contribute up to £7000 annually in a non-taxable account. Why was that tax advantage not used? It's just not knowing about it in this case.

There is a huge number of funds available in the UK and it is a big chore sorting through and comparing them. I found a number of useful sources like the website of the UK regulator, the Financial Services Authority, which has comparative tables for all types of investments and shows all the charges (why can we not have something similar from our Canadian regulators?). There is also the Trustnet website, for performance tables and charts that allows one to enter and track a portfolio with updated values.

The lack of diversification beyond the UK also needs to be corrected. Therefore, IUSA (iShares S&P500), IAPD (iShares Asia Pacific Dividend Plus), IEEM (iShares Emerging Markets) will be substituted for the UK holdings where these can be put either into ISAs or PEPs (another UK tax-free plan - it was the pre-cursor to the ISA and can still be held as a "grandfather" type of account). For regular taxable holdings, about a third of the total equities will still be in the UK but as the M&G FTSE All Shares Index Tracker. The last chunk will go into M&G European Index Tracker, a broad based OEIC fund with 0.5% annual fees and no initial charges.

It has been instructive to see how a typical passive investor can evolve a portfolio by accident that can be improved with such simple measures as better diversification, lower fee funds and use of tax-free accounts.

The next stage was to find a place to buy and hold these new assets, a big job in itself and worthy of a future post.

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