"I'm taking early retirement - how should I invest £100,000?"

Monday, 21st February 2022 13:01 - by David Harbage

Last week a good friend – let’s call him Fred - told me that he had accepted redundancy and, for the first time in his life had some capital, was wondering what to do with his good fortune. After paying off mortgage, credit card debts and allowing £40,000 for a couple of years’ spending money (in case plans to seek casual consultancy income did not materialise), Fred reckoned he had £100,000 to invest for his retirement and was looking for suggestions. His partner, Freda (not her real name) wanted to keep all the money in bank or building societies, but fancied Premium Savings Bonds – neatly utilising the £50,000 personal maximum HM Government afforded to each of them.

Fred is worried about rising household bills, notably gas & electricity, as well as house and car maintenance, and wants “to put his precious capital to work” to produce a rising income. I commended my friend on that strategy, but said that he could please Freda by placing the £40,000 in ‘Ernie’s’ care (fingers crossed that they get lucky with a big monthly win) - although mindful that the current tax-free prize pay-out, being equivalent to an interest rate of just 1%, would average £400 per annum.

While there is never an ideal time to invest in stock market assets, history suggests financial markets have proven themselves pretty efficient in pricing future prospects. Uncertainty and apparent negative news flow would seem to be good reasons to defer investment into real assets - like property and businesses – as attention shifts from Covid-induced economic shutdowns to higher inflation and rising interest rates, against a backdrop of geo-political rumblings (hopefully just ‘sabre rattling’) in the Ukraine. Most of these factors are likely to be short term – which could be defined as a period of up to two years – and serious investors (institutions, rather than traders) will be taking a much longer, pragmatic rather than emotion-led, perspective in allocating their assets and making investment decisions.

Given the current level of uncertainty surrounding the economic outlook in particular, and Fred’s inexperience in owning non-cash assets, the suggestions shown below seek to incorporate an additional layer of safety. In particular, the writer endeavoured to select investments with significant asset backing as well as trusts whose prices currently offer a double-digit discount to such assets.

1. £40,000 in Premium Savings Bonds to provide certainty of immediate worth – to supplement casual earnings and meet unexpected ‘rainy day’ expense – anticipated, but uncertain (dependent upon prizes) income, of 1% per annum.

2. £30,000 in UK company shares which offer the prospect of providing a hedge against rising inflation, producing income in excess of current cash rates and offering the prospect of rising income via dividend hikes, as well as capital appreciation as inflation positively impacts the worth of their property assets. Opted to place that sum equally between three trusts:

Firstly, Henderson Opportunities trust (HOT) – an investor in both large companies which the fund manager perceives to be undervalued (including Barclays bank (BARC) and mineral giant Anglo American (AAL) alongside special opportunities (such as North Sea oil & gas producer Serica Energy (SQZ) and Scottish house builder Springfield Properties (SPR). The shares of HOT produce an income of 2% at its current price of 1340p, which represents an 11% discount to the underlying worth of the portfolio’s assets.

Second, JP Morgan Mid Cap trust (JMF) – which invests in medium sized, FTSE 250 index constituent companies in search of capital growth. Its largest ten constituents include several well-known names: Future, Watches of Switzerland (WOSG), JD Sport Fashion (JD.), OSB (OSB), Dunelm (DNLM), Pets at Home (PETS), Vistry (VTY), Computacenter (CCC), Grafton (GFTU) and Bellway (BWY) – which together make up 45% of the portfolio. JMF shares produce an income of 2.6% at a current price of 1150p, which represents an 11% discount to the latest valuation of the trust’s assets.

Last but not least, Aberforth Smaller Companies trust (ASL) – an investor in a large number of UK smaller businesses (choosing a portfolio of approximately 80 companies from a universe of 330+, which could include firms worth up to £1.6bn). The fund managers focus on companies offering Value, in the form of being profitable today and boasting strong balance sheets, which include newspaper publisher Reach (RCH), van rental group Redde Northgate (REDD), personal credit provider Provident Financial (PFG) and bus & rail operator First Group (FGP). The shares of ASL offer an income of 2.5% at a current price of 1395p, which co-incidentally again represents an 11% discount to the underlying worth of the portfolio’s assets.

3. £20,000 in global company shares, with a greater emphasis on their growth prospects rather than immediate income attractions, choosing to invest equally between two investments:

First, Herald investment trust (HRI) – seeks capital appreciation via smaller companies in the areas of communications and multi-media – notably in information technology equipment and services. The portfolio features 350+ businesses, geographically biased towards the UK 46% (where technology firms are more sensibly valued, by contrast with the sector’s American giants), USA 23%, Asia & Japan 13%. HRI shares, which do not distribute income, are currently priced at 1965p, representing a 15% discount to the underlying value of the trust’s assets.

In addition, Pershing Square Holdings (PSH) – this FTSE 100 constituent has a Value approach to investing, as it seeks to preserve capital while also maximise long term capital appreciation commensurate with reasonable risk. Endeavouring to outperform America’s S&P 500 index, it owns a concentrated portfolio of stakes in perceived quality, undervalued companies featuring Universal Music publishing & streaming, Domino’s Pizza, Hilton hotels, Chipotle Mexican restaurants, Lowe’s DIY stores, Howard Hughes residential & commercial real estate and Fannie Mae & Freddie Mac mortgage facilitators. The shares of PSH pay an income of 1% at a current price of 2680p, which represents a 29% discount to the worth of its assets.

4. £25,000 in private company securities (businesses which are not listed on recognised stock exchanges) – primarily equity stakes, but also loans – which focus on achieving growth in capital rather than income returns, choosing to invest equally between two investments:

First, Harbourvest Global Private Equity trust (HVPE) - an investor in a diversified portfolio of various private market assets across both early investment and mature realisation stages of corporate development, with a bias to the US 61%, but also exposed to European 21% and Asian 15% opportunities. Technology & software industries account for 31% of assets, with medical & biotechnology ranking next accounting for 13%. HVPE shares are currently priced at £26, representing a significant 21% discount to the last valuation of the trust’s assets, but do not distribute income.

Plus, Chrysalis Investments (CHRY) which aims to invest direct into later stage private companies with long term growth potential (often featuring digital or thematic platforms), currently based: UK 65% and overseas 35%. The portfolio features 13 companies, ranging from payments businesses Wise (WISE) and Klarna to travel company Secret Escapes and challenger bank Starling. CHRY shares, which again does not distribute income, are currently priced at 178p, representing an attractive 27% discount to the latest valuation of its assets.

5. £25,000 in real estate investment trusts which distribute most of their revenue, arising from rental streams which are often linked to inflation and, as a consequence of anticipating rising income, offer the prospect of capital appreciation. Opted to place that sum equally between two trusts:

First, Schroder Real Estate trust (SREI) seeks to produce an attractive level of income with the potential for income and capital growth by investing in UK commercial property. Current mix is dominated by industrial & retail warehouses with 47% of total assets, and offices 40%; with geography biased towards the North of England & Scotland 35%, Midlands & Wales 24% but London just 9%. The shares of SREI produce an income of 4.2% at a current price of 54p, which represents a 16% discount to the underlying worth of the portfolio’s assets

Secondly, Civitas Social Housing (CSH) which invests in a portfolio of freehold, care-based social homes across the UK, featuring long term lease agreements with housing associations, charities and the NHS; caring for 4,391 tenants in 648 properties involving 178 local authorities. CSH shares produce an income of 6.2% at a current price of 86p, and offer a 20% discount to the underlying worth of the trust’s assets.

The above mentioned mix of 30% UK company shares (known as equity), 20% Overseas listed equity, 25% Private equity and 25% UK Commercial property suggests a bias to UK assets - rather than overseas markets. This is based on an expectation that Fred’s liabilities will be in pounds sterling, rather than an overseas currency and, moreover, reflects a belief that domestic businesses are more reasonably priced - based on both earnings and tangible asset backing.

At the time of writing, each of the above investment trusts are priced at a wider (more appealing) discount to their net asset values than their average discount to NAV over the past twelve months. For investors seeking further diversification (incorporating different fund manager’s strategies, as well as assets) and a little more risk-reward within their investment portfolio, they could also consider including the following:

UK company shares – Independent investment trust (IIT) seeks good absolute returns over long periods, via a portfolio biased towards UK equity (74%, overseas 26%) and technology sector (31%, consumer cyclical 22%, communications 15%). The shares offer an income of 1.5% at the current price of 510p, which represents a 13% discount to the worth of the trust’s assets.

Smaller company shares – North Atlantic Smaller Companies trust (NAS) aims for capital appreciation (does not pay-out income) and invests primarily in UK businesses. The trust’s shares, priced 4240p, currently offer a 29% discount to the underlying worth of its assets.

Overseas equity – Manchester & London trust (MNL) whose objective is capital appreciation, focuses on large businesses (via USA 74%, China/Hong Kong 19%, Europe/UK 7%) and the communications sector (48%, information technology 44% & consumer discretionary 26%). The shares produce an income of 2.8% and, at a price of 490p, offer a 16% discount to asset value.

Private equity – Riverstone Energy trust (RSE) invests in oil & gas businesses and, increasingly (20% of assets) renewable energy businesses. The shares do not produce an income, but at 530p currently offer a 34% discount to the latest valuation of the trust’s assets.

Commercial property – Standard Life Property Income trust (SLI) seeks growth in both income and capital via its portfolio focused on industrial & retail warehouse properties (61% of total, with offices 28% and just 2% in retail). The shares pay an income of 4.6% and, at a current price of 86p, represent a 20% discount to the underlying worth of its assets.

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.