An older investors’ guide to generating a reliable retirement income

For a sensible approach to the risk/reward trade off, try my ‘Hard Assets Mini Portfolio’, says David C Stevenson.

This week I want to return to a broader theme I’ve introduced over my last few articles: the challenge of building a sustainable, robust income for older investors who are willing to take on some risk as part of a portfolio of diversified assets.

Pensioners and those nearing retirement have unprecedented flexibility as to how to invest. But with freedom comes responsibility – which in turn requires a sensible approach towards the risk/reward trade off.

Obviously, you can build a portfolio that – in good years – generates wonderful levels of income. But that usually involves taking on too much risk. I’d say that any long-term investment plan that relies on your portfolio making an average income/capital gain of 9% a year or more is asking for trouble.

Yet, most older investors also need an income that is well above the 2.5%-3% on offer from low-risk long-term government bonds. Somewhere in the middle is a sensible risk/return trade off. I believe a carefully built portfolio of diverse assets could yield 4%-6.5% a year, which might just be enough to replace an annuity.

You can’t rely solely on bonds or equities. You might need both. And within the ‘equity’ bit, you need to be very careful about what you invest in. People talk about ‘blue-chip’ equities, but I genuinely believe these shares should be a small part of your total portfolio – unless you have a clever investment strategy to mitigate your risk.

I suspect that the majority of your equity portfolio should instead be in much more defensive businesses, with some real ‘hard asset’ backing, and a rate of return that should – though there are never any guarantees – increase in line with inflation.

I think the best way to do this is to use a ‘mini-portfolio’ of property and infrastructure funds. We want funds that pay a sensible income, backed by hard assets that are diversified across sectors and geographies.

These listed funds – they are nearly all investment trusts – should be very liquid, and always easy to buy and sell. But remember that closed-end funds come with risks too, comparable to any equity.

They can be volatile: in a bad year you might see losses of 20%-30%. If you’re investing for the long term, say the 20 years of your retirement, that volatility might be a price worth paying in a small part of your total portfolio. In return, you should be able to derive an income across the mini-portfolio of around 5% a year.

If this sounds interesting, let me introduce you to my ‘Hard Assets Mini Portfolio’. I’ve taken a gaggle (12 funds) of shares that cover a range of infrastructure and property assets. All the funds are well run, and boast assets of at least £100m, with robust income streams. They should all be able to grow their payouts over the long run, and nearly all have some degree of inflation protection.

It’s also vital to have a mix of “end customers” – in other words, the clients and leaseholders who pay the funds to use their assets, be they offices, shops or roads. The government is a great customer, and over time I’d expect more states across Europe (and the world) to get private capital involved with their infrastructure needs. But governments are also fickle, so it’s dangerous to rely on them entirely.

In this government infrastructure section, I’ve included a 35% exposure to conventional infrastructure assets, nearly always based on public/private partnerships – the three funds in the group are highly respected, with long track records, and diversified asset bases.

Invest in shops, offices and factories

Commercial property, usually owned by real estate investment trusts (Reits) is the big alternative. These invest in everything from plush shopping centres to industrial estates and smart offices in city centres.

Reits had a tough time after the financial crisis in 2008/2009. But they’re a great long-term bet on the private sector and for the most part are well run, with income-orientated investors’ interests at heart.

In the Mini Portfolio, I have weighted my exposure towards these Reits (at 49% of total assets). That’s perhaps a little too cautious. After a tough few years, sentiment is turning very positive on UK commercial property, with rents rising and capital values too.

A research note from Colette Ord at brokers Numis Securities highlighted analysis from property specialists CBRE, whose property index rose in value by 3.7% over the first quarter of 2014.

According to CBRE, all main sectors and sub-sectors saw “positive capital growth, including shopping centre assets. ‘All Industrials’ recorded the strongest total return of the main sectors, outperforming offices for the second consecutive month”.

Crucially, the “recovery continued to broaden outside of London, with ‘Rest of UK’ offices recording the highest capital value growth for 52 months at 1.1%”. Even the sector everyone loves to hate – shopping centres – saw gains, with capital value growth of 0.4% following a drop of 0.1% in January and February respectively.

But the key insight was that the spread of returns (between regions and sub-sectors) has started to narrow as the UK economy picks up speed, boosting both rental yields and capital values.

In other words, the recovery is spreading and the weakest regions and property categories are starting to catch up. That gives the five Reits in my list the opportunity to test their property picking skills ie, buy quality properties in areas on the way up.

Given these numbers, it’s no surprise that Reit fund managers have also been upping their own estimates for likely growth in the next few years. According to the Numis report “Ignis, the manager of UK Commercial Property trust, anticipates total returns in 2014 of 11%.

F&C REIT, the manager of F&C Commercial Property Trust and F&C UK Real Estate Trust, recently upgraded its total return expectations for 2014 and 2015 to 12.2% (from 10.5%) and 10.2% (from 9%) respectively. These upgrades reflect a stronger outlook for economic growth and a faster pace of yield compression”.

Diversified infrastructure funds

Sitting outside this core set of funds (three in infrastructure, five in commercial property), I have included two smaller sets of holdings. The first is in what some call ‘social real estate’ – health properties to you and I – such as GPs’ and dentists’ surgeries. This is the basis of solid, well-run outfits such as Assura and Primary Healthcare Properties. I’ve assigned a lowly 8% weighting to these businesses.

They are interesting investments, but I have some residual concerns about what is still a relatively new asset class, boasting businesses that have relatively high levels of gearing.

I’ve also included another 8% exposure to renewable infrastructure. In the last few years we’ve seen a boom in these assets, packaged up in funds and sold to investors for a steady, state-backed income. Most of the underlying assets are well known – wind and solar farms – but there’s also a wider range of green energy assets, including bio waste plants.

I’m slightly cagey about this sector. I can’t quite rid myself of the fear that governments of the future may do a Spain on these commitments – the government in Madrid recently started reneging on its deals with renewables businesses, complaining it could no longer afford the bills.

As governments in the future struggle to pay pensioners and maintain the welfare state, I can’t quite see how they can continue to underwrite massive cheques to the green energy sector. So I’ve limited my exposure to just 8% of the portfolio, based on two respected, diversified closed-end funds.

Add these 12 funds together and I think you have a great basket of well run, ‘hard asset funds’ with deep liquidity, where the blended average dividend yield is about 5%.

I’ve excluded any funds trading at a premium of more than 20% to underlying assets and I’ve also tried to include funds where analysts are pretty much certain of a progressive increase in the dividend over time.

I even think this group of funds – all easily bought through a stockbroker – could chip in say 1%-2% capital gains over the long term. The complete portfolio is outlined in the table below.

Remember, I’m not suggesting that you put your entire retirement savings in this – but if you’re willing to accept some volatility, then over the long term it should be a good way to generate a decent income from a section of your overall portfolio.

David’s ‘Hard Assets Mini Portfolio’

Fund Price Premium/ discount Yield Price returns Costs (incl perf. fee) Suggested exposure
Year-to-date 3yr 5yr
Bilfinger Berger Global Inf.
119p 12.7% 4.6% 0.8% 1.00% 10%
Int. Public Partnerships
126.9p 3.2% 4.8% 1.9% 29.1% 55.5% 1.29% 15%
John Laing Inf.
115.3p 8.0% 5.5% 2.9% 28.6% 1.78% 10%
John Laing Env. Assets
100.0p 2.0% 6.0% n/a 4%
Renewables Infr. Group
103.0p 4.9% 5.8% 3.2% n/a 4%
F&C Comm. Prop.
119.1p 13.1% 5.0% 0.5% 36.5% 118.4% 1.64% 11.0%
F&C UK Real Estate
82.0p 2.6% 6.1% -0.3% 28.7% 117.8% 2.29% 5.0%
Schroder Real Estate
54.0p 10.9% 4.6% 10.6% 90.0% 189.3% 3.52% 11%
Standard Life Inv Prop.
75.5p 15.2% 6.0% 9.5% 40.8% 168.8% 3.02% 11%
UK Commercial Prop.
82.2p 12.4% 6.5% 8.5% 27.6% 92.1% 1.63% 11%
Assura Group
43.0p 6.7% 4.2% 15.6% 4.6% 74.4% n/a 4.0%
Primary Health Properties
350.8p 16.9% 5.5% 2.2% 28.5% 100.9% n/a 4.0%
Blended yield across mini-portfolio 5.1%


  • Jezzer

    Isn’t the quoted blended yield a bit meaningless if shown before costs are taken into account?

  • Mark Smith

    A general mini-infrastructure portfolio for middle aged people would be useful with some international exposure to cover a UK collapse or higher growth outside the UK