[UK expat] sanity check first portfolio

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InnocentAbroad
Posts: 4
Joined: Sun Jun 18, 2017 1:50 am

[UK expat] sanity check first portfolio

Post by InnocentAbroad » Sun Jun 18, 2017 7:06 am

I made a New Year's resolution to start investing.

Actually, it has been several years in a row since I first made that resolution. This year I discovered Bogleheads and I appreciate the logic and simplicity to the investing philosophy. Since then, I have been trying to educate myself from the wiki and reading list. One thing that is apparent is that there are many pitfalls so I hope some experienced investors can look over my first investment plan and make sure I am on the right track.

As a background I am from the UK, but working overseas. This creates complications but also has benefits. The main issue is restrictions on opening accounts with overseas banks or brokers, which can reduce options. Currency exchanges and international banking is also a hassle. On the other hand, the country I am working in does not tax capital gains and dividends so there are no messing with backdoor doo-dahs. I can live with the trade-off!

Emergency funds: sufficient
Debt: none
Tax filing status: non-US person, only file taxes locally
Tax rate: local taxes have 0% on capital gains and dividends/interest, which is nice :-)
Age: mid-30s
Desired asset allocation: 80% stocks / 20% bonds
Desired international allocation: at global market ratio

General plan is to have a two or three fund portfolio that I can regularly contribute to, but otherwise leave to do its own thing until I am ready to retire. As a non-US person I am looking at using Irish-domiciled ETFs traded on the LSE.

A. Fixed income component

Probably most confusing part for me is choice of bond fund. There are several threads about this, and my takeaway message from that was to choose intermediate term bonds in the currency that the retirement spending will be in. In my case I have no idea where I will be in 5 years, let alone 30, so my thinking had been either:

(i) USD, since that is the largest bond market, is most international currency, has okay yields and and the local currency I earn in has historically tracked it fairly well. Suitable funds could be
(a) iShares US Aggregate Bond UCITS ETF (IUAG/SUAG) (0.25% ER) - tracks Bloomberg Barclays US Aggregate Bond Index, average maturity 7.9 years, or
(b) Vanguard USD Treasury Bond UCITS ETF (VDTY/VUTY) (0.12% ER) - tracks Bloomberg Barclays Global Aggregate US Treasury Float Adjusted Index, average maturity 7.6 years.

(ii) GBP, since it's my native currency and moving back to UK is a default future option. Possible funds are
(a) Vanguard U.K. Gilt UCITS ETF (VGOV) (0.12% ER) - tracks Bloomberg Barclays Sterling Gilt Float Adjusted Index, average maturity 17.5 years.
(b) SPDR Barclays 1-5 Year Gilt UCITS ETF (GLTS) (0.15% ER) tracks Barclays UK Gilt 1-5 Year Index, average maturity 2.98
(c) iShares UK Gilts 0-5yr UCITS ETF (IGLS) (0.2% ER) - tracks FTSE Gilts Up to 5 Yr TR GBP, average maturity 2.55 years
The first seems to have rather a long duration and the other two rather short.

(iii) Go global with a mix of bonds from developed countries. For example
iShares Global Govt Bond UCITS ETF (IGLO/SGLO) (0.20% ER) - tracks Citigroup Group-of-Seven (G7) Index, average maturity 9.6 years.

The global bond fund has a large amount of Japan and Eurozone bonds which have a very low yield and are not relevant to me, so going the USD/GBP route seems more attractive. Since I can not decide between them, is there any reason not to split the allocation between the two? Anything else I might want to consider?

B. Equities component

I can't think of a reason to weight my international allocation other than at global market ratios. This means I can keep things simple with a single fund. I plan on regular rebalancing by purchasing more funds, so I there is not much advantage to an accumulating fund. This distributing fund has been highly recommended:

Vanguard FTSE All-World UCITS (VWRL/VWRD) (0.25% ER) - tracks the FTSE All-World Index.

Something I wonder about is that this fund (as well the bond funds above) have an option to buy in either GBP (VWRL) or USD (VWRD). I've read that the purchase currency should not matter, as the value will reflect the currency of the underlying assets. Buying in GBP has lower transaction fees, so seems like the preferred option.

However, for the underlying assets, about half are from the US, while UK comprises only 6%. This gives the appearance that there is more volatility in the price when denominated in GBP as opposed to USD. Is this anything to be concerned about? Any other recommendations?

C. Cash

When I was living in the UK I contributed to a cash ISA, which is the UK government's tax-free saving account. Each year the banks love to make new kinds of ISA accounts with bonus interest rates, while dropping the rates on the old accounts to almost nothing. It's a way to fleece savers who are not attentive enough to transfer each year. Unfortunately, as a non-resident it is problematic to transfer it; in theory it is allowed, but in practise most banks will not cooperate.

I've been wondering what the best thing to do with this money is. There is no penalty to withdraw, but I will not be able to put it back if I do. However, the interest rate is bad and UK tax-sheltering has no benefit for me right now. On the other hand, if there was somewhere I could invest it usefully while keeping the tax-free status then that could be an advantage if I return to the UK.

Is there something smarter I can do with this ISA money other than withdraw it and invest it elsewhere?

Thanks for working through this long post!

TedSwippet
Posts: 1306
Joined: Mon Jun 04, 2007 4:19 pm

Re: [UK expat] sanity check first portfolio

Post by TedSwippet » Sun Jun 18, 2017 2:23 pm

Welcome.

This all looks well considered to me. Your choice of UCITS throughout shows that you're fully aware of the US tax traps if you were to hold US domiciled funds or ETFs. So I'll offer just a few immediate thoughts.

A. Fixed income. This is a bugbear of mine, too. Personally I view bonds a bit like broccoli -- healthy but not exciting. The usual rule of thumb is to hold bonds in the currency in which you're going to spend them. If you're unsure you could split, some UK gilts and some US treasuries, Euro bonds, or whatever, perhaps in a ratio that reflects the probability of you returning to the UK to retire. If you can catch his attention, valuethinker is also UK based and thinks quite deeply about bonds, so he could probably suggest finer detail for you.

B. Equities. VWRL (or VWRD) should be a fine choice. The forex component should be seen as part of the potential return rather than an uncompensated risk. VWRL contains a large chunk of US stocks because these comprise a large chunk of global market cap, so this part has a USD/GBP exchange element; other countries will have other rates to the GBP. If you're going to spend USD or non-GBP in retirement then again, the final GBP rate won't matter. The bottom line is that unless you purchase a currency hedged ETF you're always going to face some currency risk/reward, and it's not universally a bad thing at all. The purchase currency indeed doesn't matter. Just pick whichever is most convenient and/or least expensive to access.

C. Cash. Now problematic, as many UK banks and brokers won't open accounts for non-UK residents. What you might have done before leaving the UK is to move this to a stocks-and-shares ISA, use that for equities/bonds, and keep cash in your local country accounts. It's probably too late for that. And even if you did, quite a few UK brokers might insist that you move and/or close the account if you leave the UK anyway. No easy answer, I don't think. Depending on how much it is, you can either suck up the rotten rates or take the cash out and do something more useful locally with it.

Valuethinker
Posts: 32313
Joined: Fri May 11, 2007 11:07 am

Re: [UK expat] sanity check first portfolio

Post by Valuethinker » Sun Jun 18, 2017 4:45 pm

InnocentAbroad wrote:I made a New Year's resolution to start investing.

Actually, it has been several years in a row since I first made that resolution. This year I discovered Bogleheads and I appreciate the logic and simplicity to the investing philosophy. Since then, I have been trying to educate myself from the wiki and reading list. One thing that is apparent is that there are many pitfalls so I hope some experienced investors can look over my first investment plan and make sure I am on the right track.

As a background I am from the UK, but working overseas. This creates complications but also has benefits. The main issue is restrictions on opening accounts with overseas banks or brokers, which can reduce options. Currency exchanges and international banking is also a hassle. On the other hand, the country I am working in does not tax capital gains and dividends so there are no messing with backdoor doo-dahs. I can live with the trade-off!

Emergency funds: sufficient
Debt: none
Tax filing status: non-US person, only file taxes locally
Tax rate: local taxes have 0% on capital gains and dividends/interest, which is nice :-)
Age: mid-30s
Desired asset allocation: 80% stocks / 20% bonds
Desired international allocation: at global market ratio

General plan is to have a two or three fund portfolio that I can regularly contribute to, but otherwise leave to do its own thing until I am ready to retire. As a non-US person I am looking at using Irish-domiciled ETFs traded on the LSE.

A. Fixed income component

Probably most confusing part for me is choice of bond fund. There are several threads about this, and my takeaway message from that was to choose intermediate term bonds in the currency that the retirement spending will be in. In my case I have no idea where I will be in 5 years, let alone 30, so my thinking had been either:

(i) USD, since that is the largest bond market, is most international currency, has okay yields and and the local currency I earn in has historically tracked it fairly well. Suitable funds could be
(a) iShares US Aggregate Bond UCITS ETF (IUAG/SUAG) (0.25% ER) - tracks Bloomberg Barclays US Aggregate Bond Index, average maturity 7.9 years, or
(b) Vanguard USD Treasury Bond UCITS ETF (VDTY/VUTY) (0.12% ER) - tracks Bloomberg Barclays Global Aggregate US Treasury Float Adjusted Index, average maturity 7.6 years.

(ii) GBP, since it's my native currency and moving back to UK is a default future option. Possible funds are
(a) Vanguard U.K. Gilt UCITS ETF (VGOV) (0.12% ER) - tracks Bloomberg Barclays Sterling Gilt Float Adjusted Index, average maturity 17.5 years.
(b) SPDR Barclays 1-5 Year Gilt UCITS ETF (GLTS) (0.15% ER) tracks Barclays UK Gilt 1-5 Year Index, average maturity 2.98
(c) iShares UK Gilts 0-5yr UCITS ETF (IGLS) (0.2% ER) - tracks FTSE Gilts Up to 5 Yr TR GBP, average maturity 2.55 years
The first seems to have rather a long duration and the other two rather short.

(iii) Go global with a mix of bonds from developed countries. For example
iShares Global Govt Bond UCITS ETF (IGLO/SGLO) (0.20% ER) - tracks Citigroup Group-of-Seven (G7) Index, average maturity 9.6 years.

The global bond fund has a large amount of Japan and Eurozone bonds which have a very low yield and are not relevant to me, so going the USD/GBP route seems more attractive. Since I can not decide between them, is there any reason not to split the allocation between the two? Anything else I might want to consider?


Ted Swippet overestimates me ;-).

A few points:

- if the bond fund currency hedges differences in local yield don't matter (the hedge offsets the difference in interest rates). All that really matters is credit risk

- you are going to have a lot of US equity exposure if you have a global equity fund (don't forget Emerging Markets! Unless you happen to live in China/ Hong Kong in which case I think you could fairly skip them (your career etc. is exposed to them)). Maybe then you don't need US bonds.

- I would tend to take the ST gilts funds (in fact, that's exactly what I do do, living in the UK). OK the yield is more or less only the MER of the fund, right now. But if say Prime Minister Corbyn takes us for Hard Brexit, or Prime Minister Boris Johnson achieves the socialist paradise ( ;-)) then sterling interest rates are going to go up. In other words, political instability plus the somewhat risk of renewed inflation says don't bet on the very long duration gilt index.

On balance, I'd probably split it 50/50 US Treasury bond fund and short term Gilts fund. On the basis that the full Gilts index has a very long duration (a feature of the UK government is it has a much longer maturity debt profile than any other major country, in fact than any country that I know about).

This is fairly boring. Bonds should be boring. You can lose money if interest rates spike upwards, or if there's renewed inflation, but generally these countries have low credit risk, and their government bonds should be fairly safe and worthily dull.




B. Equities component

I can't think of a reason to weight my international allocation other than at global market ratios. This means I can keep things simple with a single fund. I plan on regular rebalancing by purchasing more funds, so I there is not much advantage to an accumulating fund. This distributing fund has been highly recommended:

Vanguard FTSE All-World UCITS (VWRL/VWRD) (0.25% ER) - tracks the FTSE All-World Index.

Something I wonder about is that this fund (as well the bond funds above) have an option to buy in either GBP (VWRL) or USD (VWRD). I've read that the purchase currency should not matter, as the value will reflect the currency of the underlying assets. Buying in GBP has lower transaction fees, so seems like the preferred option.


Yes. And conceptually you will retire in that currency.

Note that if the fund currency hedges, the currency of reporting/ denomination *does* matter. AFAIK those funds don't currency hedge (use currency futures and forwards to reduce or eliminate the risks of volatility between the currencies of investment and the home currency, the currency of reporting or denomination).

However, for the underlying assets, about half are from the US, while UK comprises only 6%. This gives the appearance that there is more volatility in the price when denominated in GBP as opposed to USD. Is this anything to be concerned about? Any other recommendations?


As above. No. You have 20-30 years to get worried about currency volatility impacting on your retirement standard of living. Meanwhile keep investing. By that time, we will all use the Chinese Bitcoin or whatever ;-).

UK companies are highly diversified internationally. The FTSE100 (about 84% of the index) earns 60-70% of its earnings outside of GBP. Thus, when Sterling fell by c. 10% immediately after June 23rd 2016 Brexit vote, the FTSE 100 stocks were marked up 6-7% almost immediately. This varies by company but if you look at the top 10 stocks (about 40% of the index) you find: HSBC, Shell, BP, Glaxo Smithkline, Astra Zeneca, Diageo (Johnny Walker and Guinness), BAT & Imperial Tobacco (cigarettes), Vodafone etc. Ie companies that have only limited operations or customer base in the UK. you also get the big mining companies like Rio Tinto and BHP which are almost totally USD companies.

This means even someone with 100% in UK All-Share has a lot of exposure to other currencies, primarily USD. The main advantage of not focusing on the UK is sectoral-- for example the FTSE100 has only one tech stock (Sage, ARM was bought out by Softbank last year) vs the US index which has a major tech weighting.

C. Cash

When I was living in the UK I contributed to a cash ISA, which is the UK government's tax-free saving account. Each year the banks love to make new kinds of ISA accounts with bonus interest rates, while dropping the rates on the old accounts to almost nothing. It's a way to fleece savers who are not attentive enough to transfer each year. Unfortunately, as a non-resident it is problematic to transfer it; in theory it is allowed, but in practise most banks will not cooperate.

I've been wondering what the best thing to do with this money is. There is no penalty to withdraw, but I will not be able to put it back if I do. However, the interest rate is bad and UK tax-sheltering has no benefit for me right now. On the other hand, if there was somewhere I could invest it usefully while keeping the tax-free status then that could be an advantage if I return to the UK.

Is there something smarter I can do with this ISA money other than withdraw it and invest it elsewhere?

Thanks for working through this long post!


Withdraw and invest elsewhere. Keep enough cash in the bank account for visits home.

InnocentAbroad
Posts: 4
Joined: Sun Jun 18, 2017 1:50 am

Re: [UK expat] sanity check first portfolio

Post by InnocentAbroad » Wed Jun 21, 2017 10:40 am

Ted Swippet and ValueThinker, many thanks. Your replies are informative and much appreciated.

I have some follow-up questions.

You mention not to forget emerging markets. According to the prospectus, VWRL/VWRD has about 8% in emerging markets, which I guess is the global ratio. What that fund does lack is any small-cap. My preference would be to keep things as simple as possible and have only a single fund for equities, but I'm open other recommendations if there are other funds that I could consider to increase diversification or strengthen the portfolio.

Looking at options for US treasury bonds, the Vanguard fund (VDTY/VUTY) has a low expense rate of 0.12%. However, it has a very small size, only 10M.
There are a couple of other funds tracking similar indices which are larger and more established, and have only slightly higher ER.
db x-trackers iBoxx USD Treasuries UCITS ETF (XUTD) (0.15% ER, 119M)
SPDR Barclays US Treasury Bond UCITS ETF (TRSY/USTY) (0.15% ER, 209M)

Because they seem so similar, based on the marginally lower ER the Vanguard seems to be the winner. Are there other points to consider, such as the small fund size?

The suggestion about choosing short term UK gilts was really interesting. Is there a way to predict how the value of the bonds will drop if interest rates increase? The core gilt funds have much more attractive looking returns and I wonder if there is a way to estimate the risk or effect on price that a rate hike might have versus the ST funds.

I found three possible suitable short term gilt funds that seem to track similar indices:

iShares UK Gilts 0-5yr (IGLS) (0.20%, 1520M)
SPDR Barclays 1-5 Year Gilt (GLTS) (0.15%, 494M)
Lyxor FTSE Actuaries UK Gilts 0-5Y (GIL5) (0.07%, 95M)

The Lyxor fund has a much lower ER, but is also much smaller, being only a year old. Similar to the question about the USD bonds, are there any factors to consider other than ER when choosing between them?

Thanks for the help.

Valuethinker
Posts: 32313
Joined: Fri May 11, 2007 11:07 am

Re: [UK expat] sanity check first portfolio

Post by Valuethinker » Wed Jun 21, 2017 12:07 pm

InnocentAbroad wrote:Ted Swippet and ValueThinker, many thanks. Your replies are informative and much appreciated.

I have some follow-up questions.

You mention not to forget emerging markets. According to the prospectus, VWRL/VWRD has about 8% in emerging markets, which I guess is the global ratio. What that fund does lack is any small-cap. My preference would be to keep things as simple as possible and have only a single fund for equities, but I'm open other recommendations if there are other funds that I could consider to increase diversification or strengthen the portfolio.


I think you could probably omit Small Cap, for the moment. I'd like a really good Small Cap Value ETF, and I don't know of one. Therefore I am just ignoring that issue for now. Small Cap is an effect that only works to your favour some of time, and you cannot predict when-- you can have very long periods where it works against you. And to really make a significant difference to your final wealth, you have to take a big bet (20% of portfolio +) and that increases risk.

One fund will work with you and complexity is the enemy of a good plan (said someone; Von Clausewitz said "no plan of action survives contact with the enemy" which is another great quote if you want to sound profound ;-)). But, seriously, one fund will reduce your worries, avoid rebalancing (between equity funds) and thus reduce the risk of making a future behavioural mistake.


Looking at options for US treasury bonds, the Vanguard fund (VDTY/VUTY) has a low expense rate of 0.12%. However, it has a very small size, only 10M.
There are a couple of other funds tracking similar indices which are larger and more established, and have only slightly higher ER.
db x-trackers iBoxx USD Treasuries UCITS ETF (XUTD) (0.15% ER, 119M)
SPDR Barclays US Treasury Bond UCITS ETF (TRSY/USTY) (0.15% ER, 209M)


I don't have a definitive answer on one question. Is the Vanguard fund in some way aggregated with a fund which is not available to retail investors, and thus the situation is less difficult than it looks?

Otherwise, I wouldn't touch the VG fund, I would stick with one of the other two. The difference in fee (3 basis points aka 3 /100ths of 1% p.a.) is so small as to not be material.

Note if you are buying ETFs, and there's a fixed charge per trade, that matters-- you want to do as few trades as possible. Maybe only once a quarter? And whether you have Accumulation or Distribution units matter (being UK based I go for the former).

Because they seem so similar, based on the marginally lower ER the Vanguard seems to be the winner. Are there other points to consider, such as the small fund size?


As above. I currently would not recommend the VG fund.

The suggestion about choosing short term UK gilts was really interesting. Is there a way to predict how the value of the bonds will drop if interest rates increase? The core gilt funds have much more attractive looking returns and I wonder if there is a way to estimate the risk or effect on price that a rate hike might have versus the ST funds.


Ok. Yes. Sort of. There's a thing called "Modified Duration" (or just duration, sometimes) which measures in principle how much, all things being equal, a +/1% change in interest rates (technically across the curve, i.e. at all maturities) will change the price of the bond (and therefore can be worked out as an average for the fund). So duration of 9 years, +1% interest rates, bonds should fall 9% in price. That's not total return, I stress, because the bond coupons will still arrive.

(I think there's a wiki on this, here)

(if you are mathematically inclined the modified duration is the partial derivative of the bond price with respect to interest rate changes. It's only an approximation and while it works pretty well for *small* changes, for changes of more than 1% of interest rates it doesn't work as well. There's also something buried under there called "Convexity" which is the rate of change of the sensitivity of the bond to interest rate changes (technically, the second derivative. You don't usually need to worry about that. Michael Lewis' "Liar's Poker" is an entertaining read (he worked as a bond salesman in late 1980s London in the Big Bang era) and a relatively painless way to learn something about bonds).

The rule of thumb is the duration of the fund should be less than your need for fund. So a 10 year duration fund, then use if you don't need the money within 10 years, you are OK. The reason being that if interest rates rise (bond prices fall) you can reinvest the income from the fund (and new contributions) at a higher yield (the price of bonds falls, the yield rises) and hence higher return.

The best estimate of the return from a bond is the Yield to Maturity/ Gross Redemption Yield (only Brits use the latter term). It takes into account the price you paid for the bond (which can be more or less than £100) and hence the capital gain or loss at maturity (which is normally always at £100) and the fixed coupons you receive every year for holding the bond (normally once a year, gilts mostly pay twice a year i.e. a 4% gilt pays 2 x 2% pa).

So with a bond fund, the average YTM gives you a pretty good guess of your future return from that fund*. Right now, 10 year gilt paying 1.0% ish. Not very attractive when inflation is 2.6%! But a ST gilt fund paying 0.2% is also falling behind.

* never a perfect estimate. Because the bond price fluctuates, the coupons will be reinvested at different prices (and thus yields). Unless you have something called a "stripped gilt" or "zero coupon bond" the YTM is never exactly equal to the return. The YTM calculation assumes you can invest the coupons at the same yield as you bought the bond (which is never true). In mathematical terms the YTM is the Internal Rate of Return (=XIRR in Excel) of the cash flows of the bond, including the outflow (the purchase price) and the redemption (usually at £100 per £100 face value of bonds).

I found three possible suitable short term gilt funds that seem to track similar indices:

iShares UK Gilts 0-5yr (IGLS) (0.20%, 1520M)
SPDR Barclays 1-5 Year Gilt (GLTS) (0.15%, 494M)
Lyxor FTSE Actuaries UK Gilts 0-5Y (GIL5) (0.07%, 95M)

The Lyxor fund has a much lower ER, but is also much smaller, being only a year old. Similar to the question about the USD bonds, are there any factors to consider other than ER when choosing between them?

Thanks for the help.


Size matters ;-). I'd go for one of the bigger funds. Although the ishares fund is full of bonds that don't yield much more than 0.2% (20 basis points) so the payout from that fund (which I hold) will be miniscule.

I tend to hold the ishares ones. I am comfortable with ishares as a firm (it was Barclays, now it is Blackrock). Being somewhat pedantic, they use "cash replication" rather than "stratified sampling" and "derivatives" to construct their funds (mostly). In other words, they hold representative securities in the fund of the index they are trying to match.

Not all ETF providers do that. Those that don't probably it doesn't matter. But a little voice in the back of my mind says "what happens when the unlikely occurs?" Thus (and this is partly out of laziness and partly out of a fear of another September-October 2008) I tend to hold the ishares.

You are *probably* alright on the Lyxor ETF (which I have not looked into). But bonds are for sound sleeping, and dullness to the point of somnolence -- so I opt for dull.

On gilts we are truly on a hiding to nothing as investors:

- the gilt market has the longest duration of any government bond fund that I know of - so you have maximum interest rate risk
- long term gilt yields are really low (lower than US Treasuries)
- ST gilts produce no return (but are much less sensitive to interest rate moves)
- in theory, one should hold Index Linked Gilts (which protect against inflation). But ILGs one looks at the real yield, and it's negative for most of them i.e. you are *guaranteed* to lose money in real terms if inflation is as expected over the life of the bonds

So one takes the best of a bad lot. If one has exposure to the gilt index, then I hedge it by also holding ST gilts (much less interest rate risk, no return to speak of at the moment)- -that lowers the average duration of the portfolio.

I also hold corporate bonds (Investment Grade only). Now historically they have not rewarded the investor: about the same return as government bonds (because some corporate bonds default), higher volatility. So I am betting against history here. I would not go into High Yield (aka sub investment grade or junk) bond funds-- too much risk for the returns and also the risk shows up just when you want to have money to rebalance into equities (ie periods of high economic and financial stress).

InnocentAbroad
Posts: 4
Joined: Sun Jun 18, 2017 1:50 am

Re: [UK expat] sanity check first portfolio

Post by InnocentAbroad » Sun Jun 25, 2017 10:06 am

Thank you again for the clear advice, Valuethinker; it was really useful.
I raise a glass to you :beer.

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