Coronavirus: the fund changes we must make to preserve our income
Story published April 27 2020
The drastic worsening in the coronavirus epidemic since we last wrote an update on it forces us into equally drastic action: we will now change many of the funds in our portfolios.
In essence, we will move from shares to property and other types of income-producing physical asset.
What matters now above all else is income sustainability – and some of the funds in our portfolios will not, in the radically changed circumstances of the pandemic, be able to sustain the income they have paid previously.
This is especially true of our “equity income” funds: those that invest in the shares of companies that pay dividends. Hundreds of such firms have already announced that they will suspend or cancel their dividends this year as a result of lockdown and economic disruption and the funds that hold their shares will have no choice but to follow suit. Across the London stock market as a whole, dividend cuts of as much as 50% per cent have been predicted and we cannot expect our funds to achieve a significantly better result.
Fortunately, investments that can offer more sustainable income, even during the Covid-19 pandemic, do exist and we will therefore be switching our portfolios to them.
Readers may wonder if selling the existing funds in order to buy new ones amounts to locking in a loss that would otherwise be only a “paper” one. The answer is yes but the effect is offset if the new funds being bought have also fallen. This is broadly the case with the new funds we have chosen, although they have on average fallen by less, relative to their levels just before the crisis, than those we are selling.
However, and more importantly, the share prices of the new funds have fallen by such a degree that the yields they offer actually exceed, at the time of writing, those from the existing funds. As a result, investors who switch to the new funds can expect a rise in their income – a result that must seem strange. This extra income will come, however, at a (bearable) cost: the funds that pay it offer, on the whole, limited scope for growth in capital and income over the long term.
But as things stand this is a small price to pay: the prospect of a reliable income is hugely valuable now at a time when so many companies are cutting their dividends, while the growth in capital and income that we previously expected from our existing funds will at the very least be delayed, perhaps severely, by the closure of much of the economy during the coronavirus lockdown.
You may be wondering how some funds can be expected to maintain their income in spite of the lockdown. The answer is that one way or another they invest in essential parts of the economy, such as warehouses for online retailers, energy and water companies, retirement homes and sheltered housing.
In fact, our portfolios will take a decided shift towards property and infrastructure. We already had a quarter of each portfolio in property funds and our exposure is therefore going to rise substantially. Normally this kind of concentration on one type of asset would be undesirable but these are not normal times and we must go where sustainable income is to be found.
Here then are the changes we are making to the portfolios.
We are removing all three of the “equity income” funds, as well as one of the two property funds, from our high-income portfolio and compromise portfolio. We are replacing them with five investment trusts that offer resilient income from assets such as property and infrastructure.
In detail, the funds being removed are:
◆ Artemis Income fund
◆ Ardevora UK Income fund
◆ Montanaro UK Income fund
◆ Standard Life Investments Property Income
(the LF Miton UK Multi Cap Income fund had already been removed)
In their place are five investment trusts:
◆ Triple Point Social Housing REIT (stock market “ticker” code: SOHO)
◆ Biopharma Credit (stock market “ticker” code: BPCR)
◆ Urban Logistics REIT (stock market “ticker” code: SHED)
◆ Sequoia Economic Infrastructure Income (stock market “ticker” code: SEQI)
◆ Residential Secure Income (stock market “ticker” code: RESI)
REIT means real estate investment trust.
We are currently reviewing the two bond funds in our portfolios and will update this page if we decide that they need to be changed.
Our inheritance portfolio is unlikely to need the same degree of change. We will review the holdings in detail in the coming days and update this page then.
How to make the fund changes
The actual process of changing funds will need to be carried out with great care to prevent moves in the market while the change is taking place from causing losses.
This is because, when a fund is sold, there is normally a wait of four working days before the money is received and available to reinvest in a replacement fund or investment trust. In normal times this might not be too much of a concern, although it is always undesirable, but in recent weeks we have seen the market rise by as much as 10% in a single day.
If the timing of a sale were particularly unlucky, it is not impossible that a loss of that magnitude could be made, the result of the fund you want to buy rising in price dramatically after you have fixed the price at which your old fund is sold.
There is a way around this problem, however. It involves dipping into our cash buffer – only temporarily, it must be stressed. We use the money in the cash buffer to make the purchase of the new fund at the same time as the sale of the old one, despite the fact that the proceeds of the latter are unlikely to be received for four days.
If there is insufficient money in the cash buffer to do this, as will be the case for those who have adopted our approach of having a buffer equivalent to one year’s spending, the sale/purchase will need to be done in stages.
Unfortunately this means that the whole process of selling four funds and buying five new investment trusts (in the case of the high-income and compromise portfolios) could take several weeks. But we see the risks of not carrying out the sale and purchase transactions simultaneously as too great.
There is, regrettably, yet another complication to be borne in mind. We are selling three funds and one investment trust. When you sell the latter, your investment platform will offer you a price that you then accept or decline. Once you accept a price, the sale happens and the price is set at that point, so you know instantly how much money the sale has realised.
But it’s different for the three funds. Dealings in conventional funds (“open-ended” funds, also called either unit trusts or open-ended investment companies) are made only once a day, normally at noon. Although you can place your instructions to sell or buy such a fund with your platform at any time, the transaction will not actually take place until noon on the next working day. The price you see if you look it up will be the one at which the most recent daily transaction took place – which will probably not be the price at which your own sale will actually take place.
We are back with the problem that the market could move between your placing of your sale instruction and the transaction taking place. The way to minimise this risk is to place your sale instruction with your platform close to noon – in other words, on the morning of the day you want the sale to take place, not the previous afternoon. About 10.30am should be fine.
Choose a day when the market is relatively quiet – fortunately, there seem to be more of them now than in the early, panic-stricken days of the virus crisis.
As soon as you know the sale price that is actually achieved and the proceeds in pounds and pence, invest the same sum, using your cash buffer, into the replacement investment trust. When the money from the fund sale is actually received, probably four days later, use it to repeat the process until all the old funds have been replaced in their entirety.
When it comes to selling the one investment trust we are removing from the high-income and compromise portfolios, and any we decide to remove from the inheritance portfolio, you should receive the money in two working days. This should not be the last fund sold, otherwise the benefit of the quicker receipt of the money will be wasted.
Of course, when the proceeds of the final fund sale are received, that money goes into the cash buffer.
Anyone who wants to make these changes may want to do so soon. In our view the prices of the five replacement investment trusts could rise (although nothing is ever certain in investment) because investors more widely may come to appreciate the relatively secure income they offer at a time when cash savings rates are close to zero.
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