Because I practice the art of portfolio insouciance, I missed the exact moment our Slow and Steady demo portfolio hit its peak in May. The undulating graph on my portfolio tracker tells me we were up something like 22% as the rollercoaster car crested the hill.

I wasn’t watching and my stomach skipped the ride, so all I care about is we’re still up 17% on purchase, with a cash gain of £1,600 – a smidgeon better than last quarter.

It’s strange, but like tuning in for late-night sport, the emotion is flattened when you’re not viewing it live.

Here are the bare bones:

The Slow and Steady portfolio is Monevator’s model passive investing portfolio. It was set up at the start of 2011 with £3,000 and an extra £750 is invested every quarter into a diversified set of index funds, heavily tilted towards equities. You can read the origin story and catch up on all the previous passive portfolio posts.

Platform choose

No doubt we will do better and we will do much worse. Our graph will oscillate like a skipping rope but let’s focus instead on something we can control – the cost of our portfolio now platform charges are inevitable.

In brief, whereas the cost of holding a fund through a broker or fund supermarket was previously hidden away in its Ongoing Charge Figure (OCF), that charge will now be explicit, and bigger for small investors.

There’s no avoiding it. The FCA1 has decreed that DIY investing platforms must switch to the new charging model over the next couple of years.

Before too long, we’ll all be buying so-called clean funds – funds that no longer conceal platform fees within their OCF – from brokers that cake on an additional charge for their services. Better that slightly pungent cherry on top than a scattering of putrid currents buried in the mix.

Old-style ‘free brokers’ that aren’t really free, selling funds with swollen OCFs, will gradually disappear, and our Monevator broker comparison table will help you hopscotch through the minefield until then.

For now, I’m going to choose Charles Stanley Direct as the Slow and Steady’s new clean fund, execution-only broker. Its 0.25% platform charge is the cheapest option available for a small portfolio like this one. At that rate, we’ll hand over £28.50 per year in platform fees if the portfolio got stuck at its current £11,408 value.

Once our investment needle reaches about £20,000, we may well be better off with a fixed fee broker. That moment looks a few years off yet.

The good news is that index fund OCFs continue to decline, going some way to off-setting the increased platform fees.

So while we’re in upheaval mode, I’m taking the opportunity to sell off most of our old funds and switch into cheaper versions, mostly from BlackRock’s Tracker Fund D range.

Here are our moves:

Old fund	TER/OCF (%)	New fund	TER/OCF (%)
Vanguard U.S. Equity Index	0.2	BlackRock US Equity Tracker Fund D	0.18
Vanguard FTSE Developed Europe ex-UK Equity Index	0.25	BlackRock Continental European Equity Tracker Fund D	0.18
L&G Global Emerging Markets Index I	0.52	BlackRock Emerging Markets Equity Tracker Fund D	0.28
HSBC Japan Index C	0.23	BlackRock Japan Equity Tracker Fund D	0.18
HSBC Pacific Index C	0.31	BlackRock Pacific ex Japan Equity Tracker Fund D	0.24
HSBC UK Gilt Index C	0.17	Vanguard U.K. Government Bond Index Fund	0.15

The total weighted OCF of the new portfolio is 0.18% (plus the 0.075 weighted stamp duty charge incurred by the Vanguard UK equity fund.)

That compares to 0.23% for the old version of the portfolio.

It’s possible to buy a slightly cheaper UK fund – the Royal London UK All share Tracker Z Fund – but I’m happy to stick with Vanguard as I suspect it will make up the 0.01% difference by keeping a tighter rein on tracking error.

Health warning!

Note that willy-nilly fund switching for a few hundredths of a basis point in cost improvement is not to be recommended. The change I’ve just made is worth all of £6 per year at the portfolio’s current valuation. You could easily lose many times that if the market spiked while you were hokey-cokeying your funds.

I’m only doing this because this is a demo portfolio that’s designed to present the best possible set-up for new investors.

You might also simplify the portfolio by ditching the separate US, Europe, Japan and Pacific funds in favour of the do-it-all Vanguard FTSE Developed World Ex-UK Equity index fund.

Or you can be lazier still and buy Vanguard’s one-stop-shop LifeStrategy funds.

Again, it’s a fraction more expensive than the Slow and Steady investments but a whole lot quicker to manage. Just add direct debit et voila – instant portfolio!

New transactions

Every quarter, we lob another £750 into the maelstrom, divided between our seven funds according to our asset allocation.

This quarter the funds we use have changed but of course our asset allocation remains all-important, as that’s what determines where we have our chips.

Here’s the skinny on our latest reshuffle.

UK equity

Vanguard FTSE U.K. Equity Index Fund – OCF 0.15% (Stamp duty 0.5%)
Fund identifier: GB00B59G4893

New purchase: £112.50
Buy 0.6276 units @ 17926.5p

Target allocation: 15%

Developed World ex UK equities

Split between four funds covering North America, Europe, the developed Pacific and Japan2.

Target allocation (across the following four funds): 51%

North American equities

Vanguard U.S. Equity Index Fund – OCF 0.2%
Fund identifier: GB00B5B71Q71

Sell: £3,272.86

Replaced by:

BlackRock US Equity Tracker Fund D – OCF 0.18%
Fund identifier: GB00B5VRGY09

New purchase: £3,460.36
Buy 2,714 units @ 127.5p

Target allocation: 25%

OCF has gone down from 0.2% to 0.18%

European equities excluding UK

Vanguard FTSE Developed Europe ex-UK Equity Index fund – OCF 0.25%
Fund identifier: GB00B5B71H80

Sell: £1,379.33

Replaced by:

BlackRock Continental European Equity Tracker Fund D – OCF 0.18% Fund identifier: GB00B83MH186

New purchase: £1,469.33
Buy 979.553 units @ 150p

Target allocation: 12%

OCF has gone down from 0.25% to 0.18%

Japanese equities

HSBC Japan Index C – OCF 0.23%
Fund identifier: GB00B80QGN87

Sell: £927.35

Replaced by:

BlackRock Japan Equity Tracker Fund D – OCF 0.18%
Fund identifier: GB00B6QQ9X96

New purchase: £979.85
Buy 702.401 units @ 139.5p

Target allocation: 7%

OCF has gone down from 0.23% to 0.18%

Pacific equities excluding Japan

HSBC Pacific Index C – OCF 0.31%
Fund identifier: GB00B80QGT40

Sell: £728.15

Replaced by:

BlackRock Pacific ex Japan Equity Tracker Fund D – OCF 0.24%
Fund identifier: GB00B849FB47

New purchase: £780.65
Buy 378.589 units @ 206.2p

Target allocation: 7%

OCF has gone down from 0.31% to 0.24%

Emerging market equities

Legal & General Global Emerging Markets Index Fund I – OCF 0.52%
Fund identifier: GB00B4KBDL25

Sell: £997.31

Replaced by:

BlackRock Emerging Markets Equity Tracker Fund D – OCF 0.28%
Fund identifier: GB00B84DY642

New purchase: £1072.31
Buy 992.87963 units @ 108p

Target allocation: 10%

OCF has gone down from 0.52% to 0.28%

UK Gilts

HSBC UK Gilt Index C – OCF 0.17%
Fund identifier: GB00B80QG383

Sell: £2,390.65

Replaced by:

Vanguard UK Government Bond Index – OCF 0.15%
Fund identifier: IE00B1S75374

New purchase: £2,570.65
Buy 20.253 units @ 12692.95p

Target allocation: 24%

OCF has gone down from 0.17% to 0.15%

New investment = £750

Trading cost = £0

Platform fee = 0.25% per annum

This model portfolio is notionally held with Charles Stanley Direct. You can use that company’s monthly investment option to invest from £50 per fund. Just cancel the option after you’ve traded if you don’t want to make the same investment next month.

Take a look at our online broker table for other good platform options. Look at flat fee brokers if your ISA portfolio is worth substantially more than £20,000.

Average portfolio OCF = 0.18% down from 0.23%

Take it steady,

The Accumulator

1. The Financial Conduct Authority, which has replaced the FSA [↩]
2. You can simplify the portfolio by choosing the do-it-all Vanguard FTSE Developed World Ex-UK Equity index fund instead of the four separates. [↩]

Good reads from around the Web.

Like it always does, the first half of the financial year has confounded all but the Internet geniuses who claim to have seen it all coming.

The US engine is trying to pull global growth forward, while Europe is asleep in the coach carriage. Meanwhile there’s trouble in the boiler room – China is spluttering in fits and starts. Assets have run hither and thither, with stocks and bonds up and down (and up) and the gold price crashing.

Meanwhile UK house prices are ahead nearly 4% year-over-year, which is the fastest rate of growth for three years. I was still wrong to claim an early victory for UK PLC, but the double dip recession has been revised away and more people are employed in Blighty than ever before, to the consternation of 50-something grumblers everywhere.

Indeed the most salient takeaway of the past few years is how markets and economics conspire to make fools of us all.

I may have been too optimistic – not about stock markets, but about how long it’d take to pull the global economy out of the mire. But equally wrong-footed were the doomsters who predicted we’d be feasting on tins of spam cooked over fires fueled by worthless stock certificates.

Where did these death-eaters go wrong? I think they got blindsided by moral justice, and what they perceive as the lack of it.

I saw the pre-crisis boom as unsustainable as much as anyone did, and I’ve ranted about bankers’ antics since the turn of the Century. My big mistake was to underestimate how deep and wide the subsequent slump would run.

The pessimists, on the other hand, got greedy. Nostalgic for the fear and hysteria of 2008 – markets in turmoil, investment firms crumbling, gold soaring at last – they wanted more.

So they got furious at Central Bankers like Ben Bernanke for doing his job, and endlessly churned out prophecies of doom like so many rain-dancers.

Super bad

I think some of these people underestimate just how big the blow-up has been, particularly in the US – it has seen nothing like it for 80 years.

On Friday we got an unexpectedly strong jobs report in the US – 195,000 net new hires, and revisions to last month, too. But as the next graph shows, the American recovery remains insipid compared to its super-virulent Alpha machismo of yesteryear:

Source: Business Insider

Look at that red line! Six years after the recession began, the US is still understaffed and hesitant. This has been carnage.

This is what the market’s retribution looks like, and if some of the wrong people have suffered – marginal wage earners, say – while the guilty prospered – a few of the 1%-ers, say – then tough tomatoes as far as investing is concerned. Complain to your politician, not to your broker.

Fact is nobody is very good at reading the economic runes, although like most investing maniacs I concede I have a meddling economist on my shoulder. (My other shoulder is even worse – there swaggers a midget day trader…)

The best thing for most people to do will always be to go passive and mechanical. Investment plans and economic punditry rarely mix, as Carl Richards put it this week in his usual style:

Carl says:

While it may be fun to chat about what the market might do next at your neighborhood barbeque, don’t kid yourself. What we know about the market comes down a bunch of guesses, also known as forecasts.

Forecasts about the future of the market are very likely to be wrong, and we don’t know by how much and in which direction. So why would we use these guesses to make incredibly important decisions about our money?

The answer is we shouldn’t.

If you must trade actively – and I admit I do – then look first (and more or less last) to valuations.

[continue reading…]

Currency risk arises from exchange rate moves between pairs of currencies.

If you have investments or assets in a foreign country with a different currency, you face currency risk, unless the foreign currency is pegged to your domestic currency or your exposure is hedged.

A simple example shows how currency risk affects your returns.

Suppose you’re an American investor and you put $10,000 into a European stock market tracker fund. The fund is not hedged, and so you’re exposed to changes in the exchange rate between the dollar and the euro. That is, you’re exposed to currency risk.

Let’s say that over the next 12 months the European stock market and therefore your tracker goes up 20% in local euro terms:

• If the dollar and the euro is at the same exchange rate after 12 months as when you first made your investment, your holding is now worth $12,000. (i.e. The $10,000 investment increased by 20%).

• Say the dollar appreciated by 25% versus the euro over 12 months. Your holding would be worth $9,600 (12,000 / 1.25). i.e. Your euro position now buys fewer dollars.

• What if the dollar depreciated by 25% versus the euro over 12 months? Your holding would now be worth $16,000 (12,000 / 0.75). i.e. Your euro position now buys more dollars.

As you can see, currency risk can dramatically affect your returns, from magnifying your gains to turning gains into losses in your own currency.

The basic rule is:

• When the foreign currency strengthens versus your own currency, your overall return goes up.

• When the foreign currency weakens versus your own currency, your overall return goes down.

Currency risk and businesses

Any business that operates across different territories that use different currencies will face currency risk. Businesses will be hurt and helped in different ways from exchange rate moves.

Some examples:

• If you’re a British manufacturer and your main market is Europe, you will benefit when the pound weakens. The euros you receive in return for your goods will be worth more pounds, so profits increase and/or your goods become more competitive due to their lower price in euro terms. The opposite happens when the pound strengthens.

• What if instead you’re based in the UK, your main market is America – but you also use lots of raw materials priced in dollars? Here you will still benefit if your local currency depreciates versus the dollar, but some or all of the gains will be wiped out because of the extra cost of buying raw materials with more expensive dollars.

• A multinational firm operating in lots of different countries may find these exchange rate moves broadly cancel each other out.

• Companies sometimes hold debts in foreign currencies. An unhedged move in the exchange rate can greatly increase their debt burden if they service the debt via a different currency.

Companies often hedge exchange rate exposure to try to deal with currency risk. The theory is they should concentrate on their proper business, rather than have a side business in currency trading.

However hedging does cost money, and a poor call can make a big dent in profits.

Dealing with currency risk when investing

So much for business, what about the likes of us one-man investing bands?

Opinion is divided as to whether currency risk is a good thing for us. There is some academic evidence that exposure to currency risk does not reward investors with higher returns. Others argue it increases diversification and so reduces risk, on top of the usual benefits of investing overseas.

Hedging away the currency risk – which comes built into some funds and ETFs – has its own snags. It costs money, whether born separately by you as an investor, or in the shape of higher costs via a hedged fund. You also give up potential rewards, which is always the unarguable price of hedging but still annoying when it happens.

Some notable investors believe currency risks can be ignored if investing in overseas equities for long periods. Sir John Templeton, the grandfather of far-flung investing, believed currency movements were neutral over the long-term when investing in equities.

Overseas bond funds are usually best hedged though – the shorter life of bonds reduces the time for currency affects to even out.

Not all foreign investments expose you to currency risk, especially if you’re an American investor. Many emerging market countries have currencies pegged to the dollar. This means their currencies rise and fall with the dollar, so currency risk can be ignored by U.S. investors putting money there.

Hedging as a side product of an investment

Some investments are inherently hedged.

Suppose you’re a U.S. investor, and you buy shares in AstraZeneca, the UK-listed drugs giant.

The value of your investment is determined by:

a) the performance of the AstraZeneca share price, and

b) currency risk.

The currency danger for you as a U.S. investor is that the pound may fall versus the dollar after you’ve made your investment.

Let’s say you buy $1,000 worth of Astra shares at an exchange rate of $2 to £1. You have £500 in Astra shares.

Now suppose that after some years the pound falls to parity with the dollar, so £1 is worth $1.

If the AstraZeneca share price stayed the same over the period, you’d have only $500 when you sold up and brought your pound sterling money back into dollars. You’d have lost $500 due to the change in the exchange rate.

However – the Astra share price would be very unlikely to stay the same if the exchange rate changed like this, because Astra does most of its business in dollars.

As the dollar strengthened towards parity with the pound, the dollars that Astra made overseas would be worth more pounds when repatriated back home to the UK.

Astra’s earnings and profits would thus rise in pound terms purely from this exchange rate change, and its share price would almost certainly rise too.

For US investors, such a rise in the share price could potentially cancel out for U.S. investors the loss from the exchange rate change!