Finally my delayed liquidity arrived. I have sold two large assets, leaving me with a lot of cash to redeploy.
As with an earlier angel investing windfall, when I have unexpected liquidity I follow a process. First of all I set aside taxes due, then charity donations, then other ‘IOUs’. Then I move the funds into appropriate portfolio accounts and start investing cash against my investment allocation.
However the size of the cash this time around has left me making a few tweaks to my setup.
At last, sleeping soundly at night with an equity portfolio loan
First of all I am taking the opportunity of this liquidity to pay down a significant chunk of my margin loan.
I am surprised what a positive psychological impact my loan reduction has had on me. I feel like the episode that began in December 2015, on a whim, when Mrs FvL and I decided to buy our Dream Home, is now over. Not because my assets have recovered to the pre-Dream Home level, which they haven’t. Nor because the loan is now fully repaid, which it isn’t. But the risk I took by taking out a £2m+ portfolio loan is now, for all practical purposes, gone.
To ensure my loan reduction is sustained, my process requires me to update my ‘target allocation’ – in terms of the amount of cash/(debt) I aim to hold. I’ve reduced my target to minus 17% of my net portfolio value (for context, when I kicked off in January 2016, my target was minus 50%!). In effect a target of minus 17% means I now have a Loan:Value ratio of 17:117, or 14.5%. This feels like a modest level of gearing to me.
To illustrate why I consider LTV of 14.5% as practically ‘no risk’, consider a dramatic drop in the markets. If, for instance my (diversified, multi-asset class) portfolio dropped by a third, which would be pretty worst-case by the last 30 years’ standards, then the gross value of my portfolio would drop from ‘117’ to 78. This would leave my net value down at about 61 (78 equity less 17 loan), i.e. a drop of 39%. This would be painful, sure. But it would leave my Loan to Value ratio at 17:78, i.e. 22%. This would be nowhere near the level where my loans would trigger margin calls.
I may end up pulling my target loan level in to minus 15%, or even lower if interest rates rise much above the current level. But this would be purely for round number simplicity. I do right now think the current level of leverage (i.e. max 22%) is sustainable pretty much indefinitely.
At the same time, my investment portfolio has now grown, which allows me to reconsider my risk appetite; I am, contrary to general wisdom, reducing my target exposure to bonds slightly and upping my exposure to equities – on the basis that with a bigger pot I am more resilient to a large drop.
If Rees-Mogg can do it, …. it’s time to move funds out of the UK
As to which geographies I diversify into, of course Brexit is on my mind. And, as in early 2016, it seems to me that the UK has more downside risk than upside risk. So this makes me prefer to move my cash out of the country – or at least invest it in overseas assets; I’ve pulled my UK assets down from a third to a quarter of my total, left the USA at almost 50% weight, and bumped up ‘other international’ to 20% of my total portfolio, and Oz portfolio from 4% to 5%.
As it happens, I am also concentrating my margin loan position in GBP. In effect, I am becoming quite highly leveraged in the UK, and very lightly leveraged everywhere else. Or, to put it another way, I am borrowing sterling to buy overseas assets. This is essentially a bet that the pound (in which I have a large loan) will fall, and that UK equities (which are highly exposed to overseas currencies) will rise. I’m comfortable with that bet.
My asset allocation has changed as follows:
Moving on from my risk appetite and my Brexit aversion, I’ve been trying to stay true to my Investment Philosophy. In particular, this calls for:
- Diversify in as many ways as possible. In addition to by geography and by asset class, which I’ve covered above, I want diversity across providers.
- Tax efficiency
- Minimise fees
- Work to reduce the number of underlying holdings.
I have made good progress on improving my position in regard to all of these.
Improved diversity across providers
With the new cash influx I have been spreading the money around quite a few accounts. Much as I like Interactive Brokers, it has the biggest single amount of my portfolio and I don’t need its margin loan facilities as much as I did. So I have taken the opportunity to bump up the allocation to some of my ‘lesser’ accounts, really on a ‘what if the worst happened’ point of view. These accounts have slightly higher fees, or slightly worse platforms, but I’d rather have a more even spread of my money.
The graph below shows the broker split over time. The changes look quite minor but I consider them to be significant. For me this graph represents significant progress, in that:
- My private bank’s share of wallet has shrunk. This spiked up above 35% after I bought my Dream Home, but is now below 30% and falling.
- My platform mix is simpler. Back in 2015, before the Dream Home seduced me, I had 9 different broker/bank accounts, six of which were material. Now I have five material providers, and hardly anything else.
- I’ve spread the load more equally between my four big providers. Broker D, whose coffers I had to bleed distressingly dry to fund the Dream Home purchase, has received quite a lot of love from the recent influx of cash and is on its way to 10% share again. And much as I love ‘Broker I’, and I do, I’m managing to resist the temptation to give it more than 30% of my money. Broker failure remains a key risk for me and diversification feels the best way to mitigate it.
Tax efficiency has, on one measure, doubled since 2013
In the process of allocating funds I’ve also made good progress on tax efficiency. The chief ways I do this, aside from ISA top ups at the start of the tax year, is by moving new funds into Mrs FvL’s portfolio and my personal investment company. Her unsheltered portfolio is now just about at the point where her investment income would bump her into being a higher tax payer so this lever is now at the Max position. Henceforth the lever which still has further to move is the personal investment company, where investment income is taxed at 19%.
Even since the end of last year I have made surprising progress here. The proportion of my portfolio that is not fully taxable at my personal rate has almost doubled in the last five years, from around 20% to around 40%. Even in the last six months it has shifted by almost 10% – through a mixture of ISA/SIPP topups, shifting assets into Mrs FvL’s name, and adding funds (actually, loaning funds) to my personal company.
My investment fees are now ‘only’ a 19% tax on my investment income
Finally, on one of the most important investing questions of all, I’m making good progress on reducing my investment expenses. As ever, by retaining my private banking account, I am getting stiffed here relative to truly low-cost investing. But my private bank fees, as a % of my total portfolio, are falling as I make sure funds are deployed outside the bank. In fact my annual private bank fees now account for only 0.36% of my investment portfolio, down from 0.51% less than two years ago.
My total annual fees amount to about 0.56%, down from 0.75%. Of course, these fees are still equivalent to being a 19% tax on my annual investment income, so they are still the devil’s work. But not too long ago it was hard to even buy an index tracker for 0.56%. I can’t claim to be ultra low cost but I’m getting closer.