Sonia Rehill digs into her mailbox for more of your investing questions.
Sonia is joined by David Kuo who is on hand to answer James' question about Libor, Paul's question about total expense ratios (TERs) and Mr Penn's poser about net asset values. Sonia and David also look at how to invest in bonds, how to catch a falling knife and lots more.
If there is a question about investing that you would like answered, please email Sonia at foolishquestions@fool.co.uk. If you would like to listen to previous episodes of Ask A Foolish Question, you can find them here.
You can download or listen to this podcast here.
Sonia:
Hello, and welcome to Ask A Foolish Question, The Motley Fool's podcast dedicated to help answer all your investing questions. I am Sonia Rehill, and with me is David Kuo. Welcome, David.
David:
Hello, Sonia.
Sonia:
Thank you for joining us once again, David. Are you ready for all these questions?
David:
I am – I've seen the questions, they look really exciting, Sonia.
Sonia:
Before we get started, I have a little announcement about Ask A Foolish Question, which I will save until the very end of this podcast, so stay tuned, but for now let's kick off with our first question from James. He has a question about Libor – he's been keeping an eye on it for years, as a result of a loan connected with it. He watches the 3M figures, and notes that it has been dropping quite steadily over the past number of months, and especially in the most recent weeks. Why is that?
David:
OK, so I've been having a look at the Libor 3M figures, or the three-month figures, and about a year ago, it was at 0.3%, and last month it was around 0.43%, so it looks as though it's pretty steady at the moment. Yes, it has come down quite significantly, and maybe it has got something to do with the Barclays' (LSE: BARC) scandal concerning the calculation of Libor, but ultimately I think what it's really indicating right now is that the Libor, for those people who don't know, is the London Inter-Bank Offered Rate, which is the rate of interest that banks think they will have to pay, if they want to borrow money from each other, and currently it looks pretty much as though, if they want to borrow money for three months, it will cost them approximately 0.45%, around that kind of figure. So maybe in the future, Libor will probably be more reliable, but that really depends on what happens to the regulators, and how they want to proceed with Libor.
Sonia:
Okay. Next, we have a question from Paul. He is a great believer in closed-ended investment trusts, but is concerned about new changes to the definition of TERs, and the growing trend of performance fees which don't show up in TERs. How can one get to the bottom of total cost?
David:
It is very, very difficult, Sonia, because it is almost impossible to try and compare total expense ratios, or TERs, between one investment trust and another. The other thing you have to bear in mind is that TERs are supposed to include things like the dealing cost, the stamp duty and other trading costs, but it does not include the dealing spreads, and this is another cost that many of these trusts will incur. So unfortunately, it is very difficult to try and compare one trust with another. You want to be able to compare apples with apples, but you are in fact comparing apples with pears. It would be very nice if there was a table where you could look down, and just simply say, here is the cheapest fund that I have, and I'll just pick the one with the lowest total expense ratio, but unfortunately the TER itself only includes things like dealing costs and stamp duty – it does not include training costs, and these are the things that you need to watch out for. So ultimately, when you're investing in these investment trusts, you have to have a look at the performance of the trust itself, and say, right – if I were to invest in this trust, is it giving me value for money? And if it is, then maybe that investment trust is worthwhile investing in, but if it's not, and the reason for that is because a lot of it is being eaten up by costs, then keep well away from that particular investment trust.
Sonia:
Where should he look, David, for this information?
David:
There is no one site where you can actually go to, to try and compare these things. You can go onto a company called Trustnet, and have a look at that, but that's about it.
Sonia:
We have another question about investment trusts, it's from Mr Penn. He wants to increase his portfolio of investment trusts, but is not keen on buying when they stand at a premium. He'd much rather wait a bit until they are trading on a discount to NAV, or the discount has widened, if they were already on one. He's come across various websites which allow him to set an alert for a particular share price, but can you please point him in the direction of one, if it exists, that enables you to set an alert for the level of discount to NAV on investment trusts?
David:
Okay, the simple answer, Mr Penn, is, there isn't. There isn't one single website that you can go onto that will alert you when the net asset value, or the NAV, is at a discount to the share price. There is no place that you can go to for that. So what you really need to do is to have a look at yourself, and just say whether or not that particular investment trust is representing good value for money. Remember that, if it's trading at a premium, it means that the market out there believes that this investment trust is going to be worth more in the future than it is today, which is why is it at a premium, otherwise it'll be at a discount. So therefore, yes, it would be nice to buy them at a discount, but at the same time there's nothing wrong with buying an investment trust when it's at a premium, because it may be at a premium today, but in six months or a year's time, that value may be outed, which therefore means that it will be trading at the right price.
Sonia:
Our next question is from Andrew, and it's about ETF income. He currently invests in ETF index trackers within an ISA wrap. Is it more tax efficient to invest in ETFs where income is issued as a dividend, or those that reinvest income to increase the value of the ETF?
David:
Okay, I don't think there is actually any real difference between the two. Ultimately, what you're looking at is total return. So if you're looking at an ETF that issues income as a dividend, and you reinvest that dividend back into the ETF again, you will increase the total return of your investment, but if you draw off the dividend, then, of course, your total return would be less, because you've actually spent that money in the first place. So the important thing really is to reinvest the income, as soon as it arrives, back into the ETF again, in order to increase your total return over time.
Sonia:
We now have a tax question from Mr Poole. Most of his investments are OEICs in ISAs, where, of course, he pays no tax. There are complaints that fund managers are charging a lot for their services. Would he be better off buying high-yield shares, even though he would pay 10% tax on income? Is there any way to avoid this tax?
David:
As far as this question is concerned, my personal preference is to build yourself a high-yield portfolio, rather than to invest in these open-ended investment companies, or OEICs. I believe that managing it yourself, you will be able to reduce your management fees, and therefore be able to generate a better return for your investment. So it's entirely up to you, Mr Poole – if you believe that investing in the open-ended investment companies is a better use of your time, than to manage your own portfolio, then I would say yes, go with the OEICs; otherwise, if you are happy to choose yourself a basket of 10 or 12 high-yielding shares, then manage it yourself. Personally, I would prefer to self-manage, because then I can decide what I want to put into my portfolio.
Sonia:
Next, we have a question from Scott. He's looking to balance his portfolio away from a strong equity bias. He's been looking at a number of strategic bond funds, but dislikes paying the fees. An alternative he's considering are bond ETFs, but he's not sure how they work. How do they make money for him? Do you have a preferred way of investing in bonds? If not bonds, where else would you put your cash?
David:
That is a very interesting question. The first question I have to ask you, Scott, is, why are you wanting to diversify your portfolio away from equities and into bonds? You have to accept that, if you were to invest in bonds, then the returns are likely to be less. If it is the income then you're after, then why not just simply build yourself, as in the case of Mr Poole, a basket of high-yielding shares? That would be my preferred way of doing it. But, because you're asking specifically about bonds, ultimately the bond ETFs will just simply track the bond market, and so there are a number of bond funds out there that you can invest in. One that I've looked at is the iShares Markit iBoxx Corporate Bond fund, which simply invests in a basket of corporate bonds, and you can decide whether or not you want to invest in a sterling bond fund (LSE: SLXX), or a dollar bond fund. It is a cheaper way of investing in bonds, so go and have a look at the iShares website itself, and you will be able to, on the fixed income tab, click on that, and it will give you a whole bunch of funds that you can invest in.
Sonia:
We have another question about bonds, David. It's from Richard, he is 59, and is going to be made redundant at the end of this year. He will need to move his pension from his employer's scheme to another scheme, and he's thinking of putting it into a SIPP until he's 65. He already has a share portfolio worth around £50,000, so he's thinking about putting the pension, roughly £40,000, into bonds. He has a local authority pension, which will form the backbone of his income from the age of 60. Could you comment on the sort of bonds he should be considering, and how he can evaluate the different offerings?
David:
Well, this is actually very similar to the question that was asked by Scott, about the exchange-traded funds, and in this particular case, again I would say, go and have a look at the iShares website. I've come across two bonds that are quite interesting. One of them is the iShares Markit iBoxx Dollar Corporate Bond fund. It's got a ticker code (LSE: LQDE), and this, as the name suggests, invests in American dollar denominated corporate bonds. The second one is also on iShares, and it's the Barclays Capital Euro Corporate Bond fund, and the ticker code for that is (LSE: IEAC) and this particular bond fund, as the name suggests also, invest in euro-denominated corporate bond funds. Now, what I would say is, at this particular time, if you had a choice of investing either in corporate bonds or government bonds, or government gilts, I would go for the corporate bonds themselves, rather than to invest in the government gilts, because I have this sneaking suspicion that we are seeing a bubble in the bond market, but this bond market is primarily in sovereign bonds, rather than in corporate bonds.
Sonia:
We have a question now about valuation models, and it's from Matthew. He often hears analysts talk about crunching a company's figures in their valuation models, and wondered what these models actually look like. How are they different to just looking at the key financial ratios?
David:
Right – in this particular case, Matthew, when we talk about looking at key financial ratios, we're looking at things like dividend yields, we're looking at price-to-earnings (P/E) ratios, we're looking at PEG ratios, and these are just a snapshot of the company that gives you a feel as to whether or not the company is cheap or expensive. So currently, the UK stock market is on a P/E of 12, which means that you are paying £12 for every £1 that companies make on average in the market. Now, if you saw a company that was on a PE of 10, in other words, you're paying £10 for every £1 of profit that the company makes, then you would say yes, I would say that this particular business is cheaper than the market, and it looks like an attractive buy. But the analysts, on the other hand, go one step further, and what they do is, they want to have a look at the performance of the company by projecting these profits forward. So what they do is, they construct very, very intricate spreadsheets, and these spreadsheets will have a look at the performance of the company today, and they will make assumptions about the growth in revenues over the next maybe five or 10 years. Then they will have a look at how much the costs are going to be increasing over the next five or 10 years. Deduct the costs from the revenues, and you end up with profits, then they will make certain assumptions about how much of those profits do you think the company is going to pay back to shareholders in the form of dividends, then they have this dividend stream, which they can discount over ten years, and they discount it back to today's price, and end up with a valuation for the company. So it is a very complicated process, which is what we here at The Motley Fool do day in, day out, and we religiously sit in front of our computers, and we're constructing these models all the time. Two analysts can actually be sitting next to each other, as in the case here in The Motley Fool. I sit next to Nate Weisshaar, and if we were to, for instance, put a valuation model on a company like British American Tobacco (LSE: BATS), now Nate will have his valuation model, I will have mine. He will have his assumptions as to how he thinks that the revenues will grow over time, how the costs will grow over time, and I will have mine, and then the two of us will actually sit down together, we sometimes do, and we say, what did you get on the valuation model for British American Tobacco, and he will look at me, I will look at him, we'll compare notes, and sometimes we will end up with the same figure. Sometimes we will have something completely different, and then we have a look at these various assumptions, which is why it is quite a complicated process, and it is not an ideal science, but it is as close to science as you can possibly get.
Sonia:
Right. We now have a question from Kate, she says: “Can you ask David to explain why it is not a good idea to catch a falling knife? Surely you want to buy shares when they are cheap?”
David:
Well, of course you want to buy shares when they are cheap, but you have to decide why the shares have fallen in value in the first place. Now, the reason why it's called a falling knife is because the shares have fallen in value so quickly. Anybody who's ever tried to catch a falling knife, and please don't try and do that unless you've got asbestos gloves on (no, not asbestos gloves, because they're quite dangerous also), but if you try and catching a falling knife, you are likely to get cut. So what you should try and do is to let the knife fall onto the floor first, and then go and gingerly pick it up very carefully, then you won't get cut. So in this particular case, yes – a falling knife does offer attractions to the investor, but unless you know exactly why the knife is falling, why the share price is falling, it is a very dangerous thing to do, and just because a share has fallen 10% in value doesn't mean it can't fall more than that, and it could in fact fall all the way down to zero, which therefore means that if you try and catch the falling knife when it's fallen 50%, you could end up losing the other 50% as well.
Sonia:
So do your research?
David:
Do your research, and personally I would say, just let the knife fall onto the floor first, and then pick it up very carefully.
Sonia:
OK. Ben has a question about stop losses. He has quite a diverse portfolio of funds, individual shares and ETFs. He has never set up stop losses, and thinks that his ISA account doesn't even have the ability to set up automatic stop losses. Do you recommend that investors use stop losses, or rolling stop losses, say, for example, if the price falls by 12%?
David:
My personal preference is not to have stop losses at all, because the market can be quite volatile sometimes. So therefore, let's say you go and buy a share that is a pound a share, and you put a stop loss at 10 or 12% below that. So what it means is, if the shares were to fall from a pound to 90p, you would trigger the stop loss, and then those shares would be sold for you. Now, the market can swing like that, but just because the shares have fallen from a pound to 90p doesn't actually mean that the shares are not still worth a pound. It's just that the market has been so violent, and has actually caused all the shares to fall, and you have actually been stopped out, in other words, of that particular share. You have sold shares, even though you didn't want to sell them in the first place, and you want to hold onto those shares. So personally, I would say, don't put stop losses in place, but if a share has fallen in value, let's say a share has fallen in value by about 20%, go back and have a look at the company; go back and have a look at those shares, and see whether or not it was justified for those shares to have fallen 20%. If not, then I would simply go back in and buy more shares in the first place, and take advantage of the cheaper share price, rather than to sell after they've fallen in value. I mean, a good example would have been something like Tesco's (LSE: TSCO) recently – Tesco's came out with a profits warning, and it said it wasn't going to make as much profit as it was expected to, so consequently the shares fell. Now, if you were an investor in Tesco's, and you had stop losses in place, well, bang, wallop! – you would have actually sold those shares automatically, because your stop losses would have been triggered. I, on the other hand, saw the shares fall in value, and I said, right – this is a buying opportunity, not a selling opportunity, and I went in there and bought more shares because I wanted to own the company, and I saw that the market had overreacted to the news, and guess what? – the shares are actually sort of climbing back up again.
Sonia:
Onto our next question, David – it's from Phil, and he says, in the last year, he and a few of his old university friends have decided to pool their money together and try their luck on the markets. They have a growing portfolio of both UK and US stocks, which they hold for both long-term growth and reasonably high yield. They would also like to invest in some ETF stocks, but while this sounds easy enough, it seems like the hardest of the lot to find. He wants to know if you can tell him where he can find some of the simplest ETFs, such as direct FTSE 100, or NYSE trackers. A few podcasts ago, you talked about the iShares Corporate Bond trackers. Do you have any more examples?
David:
There are three main providers of exchange-traded funds here in the UK. One of them, as you already alluded to, is iShares, which was formerly owned by Barclays, and is now owned by BlackRock, so if you go onto the iShares website, you will find a whole bunch of index trackers that you can invest in. These include not only the UK index trackers, but also American index trackers, and also overseas index trackers, such Asia and the Far East, so that was iShares. Another provider of index trackers is Deutsche Bank, and they have the db-X trackers, so again go and have a look at db-X, which is part of Deutsche Bank, and you will find another plethora of index trackers that you can invest in. The third main provider of index trackers is Lyxor, which is owned by Société Générale, and they also have a whole bunch of index trackers, so you have more index trackers than you can possibly invest in, Phil. Go and have a look at all of these various index trackers – they all differ slightly in terms of costs, so what you want to do is to try and find the one with the lowest cost to invest in, because that ultimately is what index tracking is all about.
Sonia:
Well, I hope that's answered your question, Phil. We have a question now from Marta. Marta has been looking at two alternatives to investing in the FTSE 250 index trackers. She uses Selftrade to look at them, and they are the HSBC FTSE 250 and the HSBC FTSE 250 Index Retail Income. They seem to do different things at different times. She assumed that they ought to move in unison, but sometimes they don't – one could be higher than the other, like today, the first one was unchanged, and the second one went up 0.29%. What is the difference between them, and what are the advantages or disadvantages of each?
David:
This question comes up quite regularly, Sonia, and the reason why these two are different is in the name. The second one is the FTSE 250 Index Retail Income fund, and the first one is an accumulation fund, so what tends to happen with the income fund is that that will split out the dividends, so you can do with them whatever you want, and in the first one, the dividends will be reinvested back into the index tracker again. So it really depends on whether or not you want the income, or you don't. If you want the income, you want number two; in other words, the HSBC FTSE 250 Index Retail Income fund, but if you don't need the income, you need the growth, then you want to go for the first one – the HSBC, just the straightforward HSBC FTSE 250.
Sonia:
Well I hope that's clear, Marta. We have a question now from John, and he wants to know, all things equal, is it the same taking 5% growth in equities with no dividends, or 5% income or dividends, with no growth, in draw down?
David:
I don't think there is a great deal of difference between the two. So what you're doing with the first one is, you're taking 5% growth in equities, so therefore what you're expecting is for the equities to grow 5% every year for the next few years, and the second one, you're actually drawing off those dividends, but in the first case, if you need the money, then what you will need to do is to sell some of those equities in order to generate the income for yourself. So it depends on whether or not you want the income to be coming off automatically, in which case the equities will not grow over time, but you will be getting a continual 5%. What you can do with that 5% that you draw off from the fund is to reinvest it back in, if you don't need it all, in which case the fund will grow in value. But otherwise, what will happen is that the fund will stay static, generating just 5% for you every year, or in the first case, the fund will grow in value, but when you need it, you will have to sell some of those shares in order to generate the cash that you need.
Sonia:
We have our final question now, David – it's from Ben G, and he says, “When people refer to their income portfolio, or their high-yield portfolio, or their high-growth portfolio, or their value portfolio, are these actually separate trading accounts for different shares held within them? – or are they held within one account, which could be, say, held in an ISA, and are simply regarded as separate?
David:
OK, what you can do is to have them all in the same account in the first place, but what you need to be able to do is to separate them out yourself, either in your own mind, or on a spreadsheet, how these things are going to be made up. Now, The Motley Fool has a way in which we think of a portfolio as a pyramid, and that pyramid is made up of a base, and the base contains somewhere between 40 and 60% of income funds. The next level up is the growth shares that you will have in that portfolio, and that is somewhere between 30 and 50%, and then we have this pinnacle at the top, which includes things like value shares, speculative shares, recovery shares. So the pyramid will guide your portfolio, but how you actually sort of fit things into that pyramid is entirely up to you. It is what I call the chicken and dug analogy, Sonia. What I'm saying is, if you have a farm, you can have chicken and ducks on the farm at the same time, but you need to know the difference between a chicken and a duck, because otherwise, if you just simply bring something in for Sunday lunch, you have no idea whether you're actually getting roast chicken or roast duck, and it would be nice to know what you're actually bringing in. So you need to know for yourself whether you have income shares or growth shares in your portfolio, and compartmentalise themselves into your portfolio in some way that you will know which is which.
Sonia:
Now for this little news, which you've all been waiting for – I'm sure you have been too, David?
David:
Yes, I have been eagerly awaiting this piece of exciting news.
Sonia:
We are going to be launching a video version of Ask A Foolish Question, so continue emailing your questions to foolishquestions@fool.co.uk, and sometimes we'll include it in the podcast, and sometimes we might just take one question, and just do a two-minute video response, which you can find on fool.co.uk.
David:
OK, that sounds very exciting.
Sonia:
And we're starting that next week.
David:
OK, so does that mean I'm going to get a wardrobe budget now, Sonia?
Sonia:
You might get a slight increase, David.
David:
OK, so I can afford a new singlet, yes?
Sonia:
Yes, that's right, you can. We might get you a make-up girl as well.
David:
OK, thank you very much. I look forward to that with bated breath.
Sonia:
Great. So look out for the video versions of Ask A Foolish Question from next week, and if you would like to get a question in for this video, then email us at foolishquestions@fool.co.uk.
If you would like to find out how you can make your portfolio grow, download a free report called Ten Steps To Making A Million In The Market at fool.co.uk/questions. Thank you for listening, and happy investing!
David Kuo challenged his Motley Fool analysts to pinpoint the attractive sectors of 2012 -- and they delivered! Discover the industries they selected in this new Motley Fool guide -- "Top Sectors Of 2012" -- while it's still free!
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> The Motley Fool owns shares in Tesco.
