The Transition from Active to Passive

avfc1982

Hi All,

I've been invested in the stock market in a number of guises over the past 5 years on behalf of myself and my partner. I’m by no means experienced and admittedly it's been a bit of a scatter gun approach across products & asset classes and not particularly focused on overall management costs or rigid asset allocation. The recent RDR changes have encouraged me to refocus on management costs and the impact these have on our overall returns as well as looking at stricter asset allocation and consolidate the number of holdings to ease administration.

Having recently reviewed my approach and doing a fair amount of reading on Monevator I have decided to transition our HL funds (mainly OEICS) into low cost trackers.

Alongside the tracker portfolio I also propose to keep a modest HYP share portfolio (to satisfy my penchant for a bit of a punt here and there!) which will reinvest dividends and a further wedge of cash/ISA's alongside. Where possible I’m transferring all investment holdings into an ISA or SIPP wrapper.

In summary between my partner and I we currently hold the following investments (allocations in %):

· 25% - HYP Share Portfolio (Fool Sharedealing/ISA)
Various FTSE 100 shares, yielding around the 4.5% mark per annum, divis reinvested.

· 25% - OEICS (Hargreaves Lansdown SIPP/ISA)
Asset Allocation - 75% Equity, 20% Bond & 5% Commodities
Region Breakdown - 50% UK, 20% Emerging, 15% Global, 12.5% US, 2.5% Other
Annual charges for these range from 1.25% up to 1.75% (ouch)

· 50% - Cash (ISA's, current accounts, rainy day fund, etc)

I'm looking to transition all of the OEICS with HL to the below low cost tracker portfolio, most likely via Alliance Trust to keep costs to a minimum. I eagerly await the announcement to HL’s charging structure, no doubt this will force me to move away to somewhere cheaper.

I will make monthly contributions to this tracker portfolio of around £1000 in line with the %'s below and look to rebalance every 3-6 months. Time horizon is approx 25 years and I will up my bond and cash allocation over time to take this into account.

· 20% - Domestic equity - Vanguard FTSE UK Equity Index
· 5% - Domestic value - Vanguard FTSE UK Equity Income Index
· 30% - Developed world - Vanguard FTSE Dev World ex-UK Equity Index
· 15% - Emerging markets - BlackRock Emerging Markets Equity Tracker D
· 10% - Gov bonds (Gilts) - Vanguard UK Government Bond Index
· 10% - Gov bonds (Index-linked) - Vanguard UK Inflation-Linked Gilt Index
· 10% - Property - BlackRock Global Property Securities Equity Tracker D

I’ve reduced the Domestic Equity & Value allocation down slightly as I have my HYP portfolio that overlaps this somewhat and I’ve stuck to 20% in bonds as I have a large chunk of cash that sits in ISA’s/fixed interest. I’ve upped the allocation in Emerging Markets as I’m happy to add a bit of risk to proceedings as I’m 25 years from retirement.

Just interested in people’s views on the above strategy, aware that people cannot give advice but like most I’m after a bit of reassurance that I’m heading in the right direction and I haven’t made any glaring errors or omissions.

marathonic

I'm reading a lot on the RDR changes and impact on low-cost investing at the moment. I'll not be starting my portfolio until next year but I'm seriously considering using ETF's as opposed to tracker funds. These would cost £5.95 per trade with X-O but the charges are extremely low for Vanguard's Trackers.

http://monevator.com/vanguard-etfs-uk/

My plan is to add £1,190 per month (meaning a 0.5% entry charge) and to include any dividends that I happen to receive with that months trade. It looks like the lowest cost solution to me provided you remain invested for at least 3-5 years.

The Emerging Markets ETF TER has actually reduced since that article was written on Monevator. It's now 0.29%.

Linton

I like your top down approach.
Some detailed comments...
- 15% EM and 30% developed seems a little overbalanced towards EM.
- I dont see the point of the UK Equity Income alongside your FTSE100 HYP. Too much duplication.
- With 25 years to go, a large amount in cash, and the HYP I think you could take on further risk with Smaller Companies. Perhaps the Vanguard Global SC fund with the 5% from the UK Income and perhaps 5% from the EM area.
- Both the Vanguard SC fund and the Vanguard Dev World Index have too high a % in US compared with other geographies in my view.

Wilkins

Linton wrote: »

I like your top down approach.
Some detailed comments...
- 15% EM and 30% developed seems a little overbalanced towards EM.
- I dont see the point of the UK Equity Income alongside your FTSE100 HYP. Too much duplication.
- With 25 years to go, a large amount in cash, and the HYP I think you could take on further risk with Smaller Companies. Perhaps the Vanguard Global SC fund with the 5% from the UK Income and perhaps 5% from the EM area.
- Both the Vanguard SC fund and the Vanguard Dev World Index have too high a % in US compared with other geographies in my view.

I echo this largely favourable assessment of OP's strategy, except that I would take the opposite view on the US. With a sufficiently long time horizon, I think this century will be America's, just like the last. Demographics, resources, technology, political transparency, business culture, power projection, all seem superior to anywhere else. Doesn't mean of course that there won't be bad times to buy.

pip895

I also considered moving away from managed toward passive funds a while back but decided against it. A couple of things that staid my hand - firstly - at least in theory it should be going to get relatively cheaper to hold managed funds (clean versions are being/will be launched shortly) and charges are being increased for passive trackers.

Secondly we have had a very strong rally - the markets are looking quite toppy to me and QE is not likely to end well IMO. Trackers are no good at protecting you from corrections (not sure I have much faith in your bond/guilt holdings to do you much good in this respect either, this time around) I know managers are no better as a whole at avoiding dips but there are some who do have a reasonable track record of protecting you against downside risk - it might be worth holding on to some of these for a while.

ChopperST

pip895 wrote: »

I also considered moving away from managed toward passive funds a while back but decided against it. A couple of things that staid my hand - firstly - at least in theory it should be going to get relatively cheaper to hold managed funds (clean versions are being/will be launched shortly) and charges are being increased for passive trackers.

Secondly we have had a very strong rally - the markets are looking quite toppy to me and QE is not likely to end well IMO. Trackers are no good at protecting you from corrections (not sure I have much faith in your bond/guilt holdings to do you much good in this respect either, this time around) I know managers are no better as a whole at avoiding dips but there are some who do have a reasonable track record of protecting you against downside risk - it might be worth holding on to some of these for a while.

The whole point of trackers is to avoid market timing as who can predict the future? So what if they look frothy now? If the OP invests for the long term he has a high chance of beating cash savings and inflation and also mitigating risk. He is also diversified against single stock risk as well.

How are you to know which active funds to keep and which to sell? Its luck at best.

Videos on the bogleheads site are well worth a watch to illustrate this point - http://www.bogleheads.org/wiki/Bogleheads%C2%AE_investment_philosophy

avfc1982

Thanks for your replies all. Agree that maybe the EM side looks a bit heavy, like the idea of sticking a bit in smaller companies as there will be minimal exposue to those as part of the FTSE Domestic & Developed Trackers which will be weighted toward to top end of the index.

All the commentary is that bonds currently look expensive but as part of this portfolio they are a hedge against a deflating market. When interest rates rise and bond prices come down my regular contributions will buy more of the fund and regular re-balancing will do the rest.

As chopper says I'm not looking to time the market (not even the pros can get that right), just reduce overall portfolio costs and take advanage of pound cost averaging over time. Whole idea of my revised strategy is to be more balanced across asset classes and give myself as best chance at matching the market over time, beating inflation and the pitiful interest rates currently on offer.

I'll keep an eye on how my HYP portfolio does Vs a Value tracker. I'm just above water at the moment but to make life easier I may look to move some of the funds across to a value tracker and spread the rest across the rest of the portfolio.

I'll wait and see what happens once HL announce their new charges and run some sums on the overall cost of my current portfolio vs the move to trackers, then I'll be able to make an informed decision. If the rumous of anything between 0.5-0.7% platform charge on HL are true then it will be a no brainer, I'll be off elsewhere. I'll then just need to convince HL to waive their transfer costs now they've moved the goalposts

pip895

ChopperST wrote: »

The whole point of trackers is to avoid market timing as who can predict the future? So what if they look frothy now? If the OP invests for the long term he has a high chance of beating cash savings and inflation and also mitigating risk. He is also diversified against single stock risk as well.

How are you to know which active funds to keep and which to sell? Its luck at best.

Videos on the bogleheads site are well worth a watch to illustrate this point - http://www.bogleheads.org/wiki/Bogleheads%C2%AE_investment_philosophy

If you are drip feeding in I agree with you but as I understand it he currently has managed funds - his risk is transferring out of managed funds at the wrong time.

I also think choosing active manages is not "luck at best" - it is quite easy to cut out the dross - funds sitting in the 3rd/4th quartile for years (some of them remarkably large and often associated with banks:rotfl:) This leaves you with a field that on average do beat their benchmark over a reasonable period.

bigadaj

pip895 wrote: »

If you are drip feeding in I agree with you but as I understand it he currently has managed funds - his risk is transferring out of managed funds at the wrong time.

I also think choosing active manages is not "luck at best" - it is quite easy to cut out the dross - funds sitting in the 3rd/4th quartile for years (some of them remarkably large and often associated with banks:rotfl:) This leaves you with a field that on average do beat their benchmark over a reasonable period.

Okey dokey lets see your list of outperforming funds over the next year so we can confirm this sure thing.

bigadaj

avfc1982 wrote: »

Thanks for your replies all. Agree that maybe the EM side looks a bit heavy, like the idea of sticking a bit in smaller companies as there will be minimal exposue to those as part of the FTSE Domestic & Developed Trackers which will be weighted toward to top end of the index.

All the commentary is that bonds currently look expensive but as part of this portfolio they are a hedge against a deflating market. When interest rates rise and bond prices come down my regular contributions will buy more of the fund and regular re-balancing will do the rest.

My problem is that I can't convince myself to buy in to an almost guaranteed capital loss.

Pound cost averaging makes sense in equity markets for many due to a combination of the fact that money comes available from salary at regular intervals but more importantly because whilst we believe the market will move slowly up, it will do so in an unpredictable manner.

Buying now something I believe will be cheaper in the future makes no sense to me.

Linton

ChopperST wrote: »

The whole point of trackers is to avoid market timing as who can predict the future? So what if they look frothy now? If the OP invests for the long term he has a high chance of beating cash savings and inflation and also mitigating risk. He is also diversified against single stock risk as well.
........

I dont see why trackers should be any less susceptible than managed funds to issues of timing, selling and risk. Many managed funds are less volatile than the FTSE100. That could be a reason for choosing one.