Retirement Portfolio: not so sweet

It's been a problematic few months for the portfolio, with a sharp setback at one of its major constituents not wholly offset by some decent gains elsewhere. The problem stock was Tate & Lyle (TATE) where, though we reduced the holding,

we might have been better advised to sell out completely. A profit-warning led to a substantial setback in the shares.

The portfolio is currently up by 118.8% since we started out just over five years ago. The FTSE 100 index is up 15.8% over the same period. Last time we reviewed the portfolio those numbers were respectively 121.9% and 11.8%, so the portfolio has had a three percentage point setback since the last review, versus a four percentage point gain for the market. It's a disturbing, though I hope temporary, underperformance.

On a total return basis, the portfolio's 100% plus gain, which includes dividend income, compares with an index gain including dividends of around 39.4%. I have introduced these total return measurements for all of the portfolios in the stable, because I think it shows a truer comparison of performance, particularly for those portfolios, like this one, where we are deliberately investing for income.

After problems obtaining data for the FTSE 100 on this basis, I am using the S&P UK index, which is similarly constructed and has many stocks in common.

There have been dividend payments from United Utilities (UU-) and Tate & Lyle, which in total have added some £80 to the portfolio's cash balance. The Kent Reliance PIB (KRB) pays out in a couple of weeks and this payment will be credited at the time of the next review.

Falling prices, rising yields

Tate & Lyle aside, the portfolio underperformance should be seen in the context of a relatively hostile environment in recent months for income producing investment. Notwithstanding recent more dovish noises from the Bank of England, interest rates have risen by more than expected and, since all fixed-income investments compete on this particular playing field, this has meant rising yields on gilts and PIBs.

Yields move inversely to price, so rising yields have been accompanied by falling prices. Or, to put it more correctly, prices have fallen to the point where yields have risen to compete effectively with higher interest rates. The price changes are not great in the case of the portfolio's fixed-income investments, but since these account for almost half the portfolio, they have been enough to act as a drag on performance. The same applies to higher yielding stocks, where performance is restrained because the acceptable yield-basis has shifted higher.

If rates come down, however, the portfolio will benefit from falling yields. We shouldn't hold our breath here, though. My own view is that while we may have reached an interest plateau, we could stay there for some time to come, perhaps even for the remainder of 2007.

The Tate & Lyle case

It is one of the most difficult decisions in investment to determine what to do with a stock that has been an outstanding performer when it suddenly all seems to turn sour. Over the last few year's Tate's share price has been driven by the success of its 'Splenda' sucralose product.

The company has announced that profits this year will be below expectations due to a lower than expected contribution from this source - hence the sharp setback in the price. Note, however, that we aren't talking about an absolute profits setback at Tate & Lyle, just a moderation of its previously high rate of growth. Profits are still expected to be well ahead of last year.

So, here's the conundrum; do we sell on the basis that the news might get worse, or buy on the basis that it might be an overreaction?

I'm ruling out buying, simply because I don't want to reverse the exposure reduction exercise we carried out last time round. We haven't got the cash to buy more shares, and I don't want to sell anything else to fund a purchase.

Normally a profit warning accompanied by a greater than 15% drop from an all-time high would be a cue to exit from the shares. That's certainly what one should do with supposed growth stocks. But this portfolio operates to different rules. Its hallmark is inaction and the deriving of income. We didn't buy Tate & Lyle at the outset because it was a growth stock, and it therefore seems harsh to judge it by the same yardsticks.

The shares are still selling at the same price (roughly) they did a year ago and we are still getting a fantastic income on our book cost on the shares, so I have no qualms about doing nothing and leaving the remaining holding as a solid part of the portfolio.

I might have cause to regret this relatively relaxed view, but we meet that particular issue in the future, if and when it becomes necessary.