The Big Theme
If you've worked out your core allocation to mainstream assets such as equities and bonds you may want to allocate a small portion of your individual savings account (Isa), perhaps 5-10 per cent, to more unusual areas. This can provide some added return and reduce risk through diversification. This method of portfolio construction is known as 'core and satellite' investing.
Even if you have a smaller Isa portfolio you could invest the bulk of it in one or two multi-asset funds and then put a small portion in some more unusual funds, adding to them as the size of your Isa grows.
Or you could use exchange-traded funds (ETFs) for your core holdings in mature markets where active managers find it hard to outperform, and active funds in less well researched areas such as emerging markets or smaller companies, where a good active manager can add value.
You will often find more unusual funds in the Investment Management Association's specialist sector, although with both open-ended funds and investment trusts, more unusual choices can have a high total expense ratio (TER) and in some cases a performance fee. In this case, you might want to consider using ETFs, which have lower costs, for your satellites as they offer access to all sorts of assets including ones you might not be able to access via an active fund. Read more on ETFs
Here investment advisers set out their picks of satellite funds for cautious, medium and adventurous risk appetites.
Adding satellites is better for those with medium or high risk tolerances. "Satellite funds tend to carry more risk than core holdings," says Tim Cockerill, head of collectives research at wealth manager Rowan Dartington. "Within a cautious strategy the scope to add a satellite is restricted."
He suggests Baillie Gifford Diversified Growth. "This invests in a broad range of asset classes, but importantly includes ones that might not ordinarily be considered, for example emerging market bonds, private equity and infrastructure," he says. "Baillie Gifford is a cautious investment house with loads of experience and the fund has been performing well with low levels of volatility."
Gavin Haynes, managing director at Whitechurch Securities, suggests M&G UK Inflation Linked Corporate Bond. "This fund is an alternative or complement to directly holding index-linked gilts," he says. "It invests primarily in investment-grade UK inflation-linked corporate bonds and other fixed- interest securities such as floating rate notes, using several assets to try to provide a return in excess of UK inflation. It is managed by Ben Lord, a member of M&G's highly regarded fixed-interest team."
He also suggests Jupiter Absolute Return. This fund had initially disappointed when it did not provide some of the spectacular returns fund manager Philip Gibbs had chalked up with other funds, but over the past year it has managed to beat its sector average, placing it among the top 25 per cent of absolute-return funds. "While a positive return is not guaranteed, the manager takes a cautious approach and the fund has offered respite in periods when stock markets fell, such as last summer," he says. "Mr Gibbs is highly regarded and seeks opportunities across asset classes and instruments with the aim of providing a positive return irrespective of market direction."
Mick Gilligan, head of research at broker Killik & Co, suggests Bluecrest All Blue, an investment trust that provides access to an offshore fund of hedge funds that invests in a diversified portfolio of strategies. Bluecrest's focus is on generating capital growth while maintaining low levels of volatility. "Bluecrest is not correlated with equities, the shares are liquid and it has preserved capital well during periods of market weakness," he says. "There is a risk that it moves to a wide discount to net asset value (NAV) but its board is obliged to buy back stock if it trades at a discount wider than 5 per cent for 12 months."
The trust is currently on a discount of -3.38 per cent, and has made positive NAV returns in each of the past five years, including more than 12 per cent in 2008 when equity markets plummeted.
Mr Cockerill suggests Threadneedle American Smaller Companies Fund. "Investing in smaller companies is a good way to add potential for growth into an Isa," he says. "Small companies have the potential to grow more substantially than large-caps because they are more dynamic, can react to change quickly, are often owner-managed and operate in niche markets. If they are well run, profitable, have a strong balance sheet and are in a strong market position they can do very well, and over the long term they tend to outperform large-caps.
The US is the world's largest economy and is still very dynamic and innovative. It is recovering from the economic and financial crisis more strongly than the UK and Europe, so is an environment in which small companies can perform well. With this fund investors may benefit from the US recovery as well as a quality long-term holding."
Mr Haynes suggests First State Global Listed Infrastructure, which invests around the world and aims for a total return from income and long-term capital growth. "It offers exposure to a defensive non-cyclical growth area and offers an added level of global diversity to an investment portfolio," he says.
He also suggests Investec Emerging Market Local Currency Debt. "This fund is designed to benefit from the superior performance potential of fixed-interest instruments and currencies of the world's less developed economies, many of which have lower debt levels and healthier balance sheets than developed western economies," he explains. "It aims for long-term income-driven returns from corporate and sovereign bonds in both local and hard currencies. The fund acts as a useful overseas diversifier within the bond component of a portfolio. However, emerging markets assets remain sensitive to global risks so this area can be more volatile than other fixed-interest investments."
Mr Gilligan suggests L&G UK Alpha. "This UK equity fund is biased towards smaller companies so has good long-term growth potential, although if the market weakens this fund will probably fall further because of this. The fund has an experienced manager in Richard Penny and an excellent long-term record."
Adventurous investor satellites
Mr Cockerill suggests the recently launched Schroder Small Cap Discovery Fund run by Matthew Dobbs, who has considerable experience of Asian investing and also runs the Schroder Oriental Income investment trust. "Schroder Small Cap Discovery will also invest in emerging market small caps, as these are expected to perform very well over the coming decade," says Mr Cockerill. "The risk is higher, but the potential rewards could be very good. As you would expect from Schroders, the fund is very well resourced."
He also suggests Montanaro European Smaller Companies Trust, which he describes as a "high- quality holding. It is on a -12.23 per cent discount to NAV and invests in high-quality companies, with a modest level of debt at 109 per cent. It holds around 45 stocks.
"Being an investment trust it has the potential to be volatile, but as a long-term holding exploiting both short-term recovery potential following the European crisis and long-term growth, for risk seekers this is well worth looking at."
Mr Haynes suggests Allianz Brazil. "Despite Brazil recently overtaking the UK as the sixth-largest economy in the world, most UK investors have little or no exposure to it," he says. "However, its economic growth is robust and stock market valuations don't appear stretched, given the scope for profit growth in many areas. The Allianz Brazil fund has a concentrated equity portfolio and aims to exploit opportunities including emerging affluence and domestic infrastructure spending. You should be prepared to take a long-term view and accept risks attached to emerging market equities: a slowdown in global growth and increased risk aversion would hit these markets as they continued to be viewed as higher risk."
He also suggests Artemis Global Energy. "This has strong long-term structural growth prospects," he says. "Fund manager John Dodd invests in a mix of established names and more speculative global exploration and production companies. The fund aims for long-term absolute returns but may experience high volatility as Mr Dodds backs his convictions strongly."
Mr Gilligan suggests Qatar Investment Fund, an investment trust exposed to a high-growth economy. The trust yields 3 per cent and trades at a discount to NAV of 14.07 per cent. But Qatar is a frontier market and so there is always potential for political risk and corruption.
Satellite fund suggestions
Source: Morningstar, *Artemis as at 23 March 2012.
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