Asset Allocation Strategy 3: Nigel

Nigel is a 62 year old entrepreneur and is ready to retire. He has spent his life building a chain of jewelry stores that specialize in custom gold jewelry. From an early age Nigel discovered that he enjoyed drawing and pursued art at school.

A good family friend, who is in the gold business, recognized Nigel’s potential for design and proposed going into business together. Nigel would design the jewelry and the family friend would supply the gold and remain a silent partner.

When they started the business together it was decided that Nigel would slowly buy out his business partner over a number of years, which was completed almost 10 years ago. As such Nigel now owns 100% of the company.

Like most entrepreneurs, the majority of Nigel’s wealth is in his business, but due to being involved in gold he has built a substantial gold reserve that he keeps at home in a safe. He understands that during retirement he’ll need a steady income to maintain his standard of living, but his current asset allocation is very illiquid.

He plans to keep his gold reserve intact, while investing the proceeds of the sale of his company in a way that provides the best chance of maintaining his standard of living, as well as the buying power of this capital.

The following summarizes Nigel’s financial situation:

  • His company is worth R50 000 000 and his gold reserve stands at a current value of approximately R5 000 000.

  • He needs R100 000 per month to maintain his standard of living and this amount needs to increase by inflation each year.

Nigel has the ability to convert his gold to cash if need be, and plans to use this reserve to pay for any unexpected expenses that fall outside those that dictate his standard of living cost.

Although he believes that the gold investment should be sufficient for small to medium sized unforeseen expenses, he aware that there should be a small growth component to his R50 000 000 investment. This growth component needs to cover both inflation and the possibility of a large unforeseen expense.

Nigel is aware that around 8% of his entire portfolio is made up of gold. He has also read through the content on this website and understands the importance of diversification. Thus, he has elected not to invest any of the R50m in assets that are positively correlated to gold.

The following summarizes what Nigel requires:

  • R100 000 per month, which is R1.2m a year. Thus he is drawing approximately 2.40% from the R50m investment a year (1 200 000 / 50 000 000 = 2.40%).

  • He deems inflation will average 5% per year.

  • He believes that achieving 1% per year growth in addition to the above should help mitigate any significant unforeseen expenses.

  • Thus Nigel is looking at making a return of around 8.40% (5% + 2.4% + 1%) per year to achieve his goals.

  • He also does not want any exposure to assets that are positively correlated to gold.

Nigel’s entrepreneurial experience has resulted in him being quite hands on with regards to his money, and after studying the material on this website he decides that an asset allocation of 80% fixed income and 20% equity should be sufficient.

He first considers the fixed income allocation. He is aware that the income return component can be achieved in a few ways such as investing in standard bonds, inflation-linked bonds and REITs to name a few.

However, he neither has the means to transact directly in these markets, nor the knowledge of how much to invest in each asset within the fixed income category. He decides the best way forward is to use an asset manager to manage this portion of his portfolio.

He manages to find a unit trust that has a mandate which targets the income component of return in a diversified manner. The allocation within the unit trust is split as follows:

  • 30% in the money market

  • 30% in normal bonds

  • 20% in inflation-linked bonds

  • 5% in preference shares

  • 15% in REITs

He then turns his attention to the remaining 20% equity allocation he requires and looks into the various unit trust offerings. After considering a number of options he realizes that the active management route may not be appropriate for him for his equity allocation.

The reason is because almost all of the unit trusts he researched had some sort of exposure to the mining industry, and those that didn’t made no mention of a mandate that avoided such companies. Nigel realizes that he’ll have to construct the equity allocation himself to avoid over exposure to mining companies.

Nigel plans to spend his retirement relaxing and doesn’t have the energy to research individual companies. So he turns his attention ETFs because he understands that by investing into one ETF he has exposure to a number of companies and achieves the golden rule of diversification.

Another aspect of ETFs he enjoys is the fact that they offer exposure to specific sectors within the economy such as financials, resources and industrials. This allows him to have exposure to equities while avoiding those equities that deal in mining. He knows that mining companies are generally associated with the resources sector, with this in mind he decides on an equity allocation as follows:

  • 50% in an ETF tracking the financial index

  • 50% in an ETF tracking the industrial index

Thus, Nigel’s total portfolio is as follows:

  • Fixed income – 80% in a single unit trust

    • 30% in the money market

    • 30% in normal bonds

    • 20% in inflation-linked bonds

    • 5% in preference shares

    • 15% in REITs

  • Equities – 20% in two ETFs

    • 50% in an ETF tracking the financial index

    • 50% in an ETF tracking the industrial index

Next: Utility Theory: Classical Economics

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