Investor sentiment has rapidly improved over the past quarter. There is a feeling that the world’s more acute economic problems are now behind us and as a result a modicum of economic growth is being factored into stock markets. Against this background, the FTSE All Share Index has risen strongly by more than 8.5 per cent over the three months to the end of January.
The portfolio is not far behind with an increase of 7.9 per cent. It has outperformed both the FTSE APCIMS Income Portfolio Index and the average mixed investment fund over the same period. Since Wise Investment took over its management two years ago it is also ahead of comparable funds.
However, the strong surge in stock markets over the past few months has made Tony Yarrow, director of Wise Investment and manager of the portfolio, nervous.
He says: ‘When things go up so fast, one has to be a little bit cautious. I spend a lot of my time looking at charts, and stock markets don’t move in straight lines, they are jagged, they move up and then people take profits and they go down. So I think there is a good chance that the market will give back some of the ground it has made in recent months.’
As a result, he has taken the opportunity at the quarterly review to adjust the portfolio and give it a more cautious stance. He has consequently reducing his holdings in six funds, sold one holding altogether, topped up two existing holdings, and added three new ones.
The holding that was sold was European Assets trust, whose price has risen by more than 40 per cent since the beginning of June last year. Yarrow explains: ‘The trust is excellent, in my view, but is fully valued at present. It has had a tremendous run – 40 per cent, it is the sort of gain you would be happy with over five years let alone six months.’
He has also reduced his holding in Standard Life European Income, another of the portfolio’s top performers over the past three months that saw a price rise of 13 per cent. And its exposure to UK shares has been trimmed by selling units in Invesco Income Growth trust, Evenlode Income and JO Hambro UK Equity Income. Two of the bond holdings were also reduced: Investec Emerging Market Debt and Invesco Perpetual Corporate Bond.
One of his reasons for taking profits from these funds was to enable him to increase the portfolio’s weighting to commercial property, which now stands at 22 per cent. This increase has been achieved by topping up the holding in Picton Property and putting a significant slug of money into Standard Life Property Income.
He explains his rationale: ‘The sector contains some excellent value, following the slump that has lasted over five years. Valuations are low – the managers of the Picton Property trust pointed out recently in their last quarterly update that the average valuation of the office properties in their portfolio outside London was roughly half the cost of rebuilding them.’
Yarrow adds: ‘Because Picton is trading at a discount of roughly a quarter of its net asset value, it means that a new investor in the trust is buying office properties for only just over a third of the cost of building them.’
He says anecdotal evidence suggests that demand for commercial property may be showing early signs of recovery. ‘It’s like the first snowdrop in spring – that’s what I am trying to capture - before the summer arrives.’
He points out that the high yields on the property trusts also give him scope for greater flexibility with the rest of portfolio, enabling him to choose lower yielding investments if he wants to. Standard Life Property Income, his new acquisition, is currently yielding close to 8 per cent, while Picton has a yield of 8.6 per cent.
Despite reducing holdings in two fixed income funds, he has topped up an existing bond holding and added a new one. Both conform with his intention of giving the portfolio a more cautious stance. He has added to his holding in Standard Life Global Index Linked Bond fund, to provide extra inflation protection, and acquired the Smith & Williamson Short Dated Corporate Bond fund, which he describes as ‘one of the least volatile funds we know in the fixed income space’.
Yarrow has also introduced a new equity income fund into the portfolio, RWC Enhanced Income, which is managed by Nick Purves and Ian Lance. The duo previously worked for Schroders where they set up the Schroder Income Maximiser fund. The RWC fund operates on the same lines, aiming to preserve investors’ capital and deliver a constant annual yield of 7 per cent from a conventional equity income portfolio, with extra income generated through the sale of ‘covered calls’ on the stocks held.
Yarrow explains: ‘This fund invests cautiously, and only in large companies with very strong balance sheets. Although the downside of the covered calls is that investors could lose out on some capital gains if there is a further significant rise in the stock market, this seems a risk worth taking at the moment in return for the higher income.’
According to Yarrow, the stock market is unlikely to continue to rise strongly in the short term. He feels it is only natural that there will be a correction. In the meantime, he will be watching to see whether his expectations for the property market are starting to come good.
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