Wednesday, 19 March 2014

Family Planning

Stylized illustration of parents with two children as red figures.
Source

Regular readers may be aware that I have developed a new comprehensive approach designed to deal with eventual inheritance issues. This is not my favourite subject, as it deals with something that I won't be around to enjoy, but is a necessary part of modern family financial planning.

One element of this was investing in SIPPs for my kids. Here's an update...

I've decided on SIPPs for three main reasons:
  • the money is immediately outside my (and my wife's) estate [as I understand it - DYOR]
  • the kids cannot fritter away the money (until they are older and wiser)
  • the Taxman pays you to do it, although there is a pretty tight limit on the amount that benefits from this unexpected largesse:  an initial payment of up to £2880 grows, after a month or two of bureaucracy, by a tax-free 25%. Nice - somehow that is the most attractive feature...

What is more, with job pensions becoming less and less generous, this additional pension should make their later lives (and the lives of our putative grandchildren) more comfortable.

Overall strategy

The challenge here is one that I am working on in the wider DIY Income Investor portfolio: how to develop an investment process that requires less and less input - and, in the event of my own exit from this world, minimal administration for the family.

The strategy that I am trying out is geographically diversified high-yield income-oriented Exchange Traded Funds (ETFs .- in this case high-yield dividend shares or high-yield bonds. These ETFs consist of diversified holdings but follow, more or less mechanically, a specific benchmark index. I am working on the theory that the highest-yield ETFs of this type indicate that they are out of favour with the market, and so may provide some capital gain *IF* (err.. that is a big 'if', by the way) the market is over-cautious. (On the other hand they may slump in value.)

What to buy?

So, back to the SIPPs. There was no particular difficulty opening two of them (one of them a 'Junior SIPP') for my two kids: I used AJ Bell YouInvest because I was familiar with its forerunner iSIPP.

The next step was to decide what to invest in. I chose to continue the broad allocation of the DIY Income Investor portfolio and split the amount into two chunks: one oriented to high-yield dividend shares and one aimed at high-yield bonds. Taking my money to the London Stock Exchange (LSE) the choices were:

VHYL

VHYL is the most geographically diversified high-yield dividend ETF available on the LSE, with over 1,000 different stocks from around the world. This ETF "seeks to provide both diversified income and capital appreciation by tracking the performance of the FTSE All-World High Dividend Yield Index, a large- and mid-cap market-capitalisation-weighted index of developed and emerging market common stocks with generally higher than average forecasted dividend yields". One-third of the ETF is invested in the US, 13% in the UK, over 6% in Australia and so on. This version of the ETF is denominated in Sterling, making it easier for a UK investor to track. And, as Vanguard has led the field in providing low-cost ETFs, it is one of the cheapest, with a Total Expense Ratio (TER) of 0.29%.

But hold on: what is the yield? Bloomberg is quoting it currently as 2.5%: however, the information sheet provided by Vanguard points to the 4% yield of the underlying index. The problem appears to be that the ETF itself is too new to have established a full 12 months of statistics - so I expect this 'trailing 12 months' yield to increase. Nevertheless, diversification always comes at the cost of lower yield, so - in this case particularly - I am trading security for yield.

SHYU

The SHYU ETF aims to track the performance of the Markit iBoxx USD Liquid High Yield Capped Index, which is "designed to provide a balanced representation of the US Dollar high yield corporate market by the means of the most liquid high yield corporate bonds available  [...] The maximum original time to maturity is 15 years and the minimum time to maturity is 1.5 years for new bonds to be included and 1 year for bonds that already exist in the index. For diversification purposes the weight of each issuer in the index is capped at 3%."

It is, obviously, priced in US$ (US Dollars) but quoted in London in UK£ (Sterling). On the interest-rate risk: it seems to be the accepted wisdom today that fixed-income securities are heading for a fall with the QE 'tapering' - the reduction of government debt purchases.

The current yield is around 6% - quite high for an ETF. But there might be some strange results - in the form of a kind of yield mirage effect. The current UK£  yield is attractive. If the value of the US$ falls in relation to the UK£, this will affect both capital and income, so although the UK£ income will actually fall, so will the UK£ capital value, and the yield could remain the same. Alternatively, if the US$ capital value of the securities falls (due to 'tapering'), the US$ yield will rise (at least in the short term).

Rinse and repeat...

So, that's the the plan. Bear in mind that this is not yet a complete SIPP portfolio but just the starting point. Given that the new year tax year beings soon, I'll be able to top up again with some new ETFs to continue the high-yield / low-maintenance / diversification theme.


I am not a financial adviser and the information provided does not constitute financial advice. You should always do your own research on top of what you learn here to ensure that it's right for your specific circumstances.

6 comments:

  1. Lucky kids you have there! :)

    I wouldn't bother with the high yield bond ETF for an ultra long-term portfolio like this. It's pretty much an axiom of finance that if the corporate bonds do okay, the shares will do far, far better.

    If you want to dampen the volatility for some reason (how old are they? can they read statements? ;)) then I'd just go with an ETF of UK government bonds.

    Just my 2p. :)

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    1. Thanks Big M

      Half of the holdings are in the global shares ETF. Year by year I will be buying different more specific ETFs that I am happy to hold for a long tim. The 'signal' I am experimenting with is yield - as this indicates 'out-of-favour-ness'..I'm hoping for either continued good yield or a capital gain.

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  2. I agree with Monevator - and have been thinking of doing the same thing as yourself, investing for my kids. If you can't take a long term approach for them, what's a long term approach for? So what will yield the best, long term? High yield debt is not a bad solution to the problem. Mix that with equities and that would do for me.

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  3. If you have enough income to put into Child Sipps then you are likely to be a 40% tax payer. So in effect you are paying 40% tax to get 20% relief in order to pass it down a generation and lock it up until at least age 57 according to the budget but this is set to extend automatically with State pension age -10 years.

    There are probably more tax efficient transfers possible such as some VCT /EIS products to avoid IHT.

    OR -assuming higher rate tax payer, look at salary sacrifice with employer making contribution to YOUR SIPP, saves 40% tax, + 2% ee ni + up to 13% emp ni which they may care to rebate for your benefit.
    This also could bring your income below 50K threshold for child benefits which assuming 2 children would save £2K on the earnings between 50-60K. A potential saving of 40%+2%+say 8%+20% = 70% on the 10K between 50-60K.

    Assuming budget goes through, then take the cash out of YOUR SIPP at age 55, hopefully paying no more than 20% lower personal tax and transfer to CHILD SIPP and receive another 20% tax rebate to balance the 20% you have paid or CHILD ISA for flexible access to money should they need it sooner.

    So perhaps look at Child sipps following your own early retirement... or who know, even Grandchild Sipps moving wealth down 2 generations!

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    1. Thanks Anon - all good stuff, most of which I have done - in particular I have tried to avoid giving the Taxman 40% of what I earn by salary sacrifice, as you suggest.

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  4. Deja Vu, I opened a Youinvest SIPP for my 7m old daughter a few months ago and it is entirely invested in VHYL. As with the other posts, I don't see the benefit of fixed interest over a 55+ yr investment period, especially starting from a period of low interest rates as we are now. The fixed interest portfolio would lose capital value if rates rise potentially wiping out the yield over 2-3 years or more. One gripe I have about VHYL
    is that it is heavily exposed to the US which is an expensive market at present, but haven't found a better one-shot alternative. I use Youinvest's monthly regular investment service at £1.50 a pop to keep the trading cost low.

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