The Big Theme
We may have climbed out of the depths of the financial crisis but growth is still muted and the path ahead remains unclear. While income has dominated the investment scene, for those investors looking for growth, there are still some attractive options.
Naturally enough, when looking for growth most investors immediately turn to emerging markets - but we've identified four other areas that investment experts say can continue to offer growth.
Technology has done well this year with the Nasdaq returning 19 per cent over the first three months of the year, bouyed by many tech companies reporting a set of positive 2011 results. Technology funds have also been among the top sectors over the last three months. Most analysts believe this is more than just a short-term bounce - as the economic outlook improves, particularly in America, companies are expected to invest in their infrastructure again and upgrade their systems giving way to increased spend with technology companies.
The proliferation of devices such as smart phones and tablets continues to grow strongly - and Anthony Burton, manager of the GLG Technology Equity Fund, expects that over 2013 a billion of these will be sold. This in turn benefits chip companies such as UK-listed ARM Holdings.
The increase in use of social media is also a key driver. "Being able to target adverts at consumers when you know who they are, who their friends are and where they live, is attractive enough a proposition," says Mr Burton. "However, it is even more attractive when the price you pay for that advert is a tiny fraction of what you pay to advertise in traditional media such as print and TV. This will create big winners and losers from an investment perspective."
While there have been recent concerns that the upcoming Facebook initial public offering (IPO) is overvalued and indicative of a new tech bubble, Mr Burton argues that it is rather a symptom of change. There were similar fears surrounding the LinkedIn IPO last year, and fund managers said that the situation with regard to this is not a reflection on the rest of the sector.
Tech companies today are in a very different state to those at the turn of the millenium - they are cash rich with good balance sheets. Read more on this
Technology, media and telecoms is a diverse and also at times volatile and high risk sector, so a diversified fund run by a team of specialist investors can be a good way to access it. A number of advisers favour Herald Investment Trust which IC tipped in February. Read our tip Another option is IC Top 100 Fund Polar Capital Technology Trust.
In the open-ended space, Adrian Lowcock, senior investment adviser at Bestinvest, suggests Henderson Global Technology. For those who do not want to opt for a pure play technology fund he suggests Liontrust UK Smaller Companies which has around a third of its assets in technology.
Infrastructure funds have performed strongly relative to the FTSE 100 over the last year and their share prices have not suffered the volatility exhibited by the wider stock market, while their dividends have increased. These vehicles also have a relatively low correlation to equities in the pattern of their returns, in part because their assets include government backed projects which are not subject to wider market or economic forces.
"Overall, the outlook for the UK and wider infrastructure market continues to be positive and investment across the sector remains a key driver of economic growth," says Giles Frost, director at Amber Infrastructure which runs the International Public Partnerships investment trust. "In the UK, the government has outlined its commitment to infrastructure investment through the National Infrastructure Plan and the significant role that the private sector will have in funding and developing the £200bn programme will provide a broad range of attractive investment opportunities going forward."
Chris Hills, chief investment officer at Investec Wealth & Investment, adds that infrastructure funds have held up well in the recent stock market upheaval and with no sign of any increase in base rates for savers, he expects the income available from infrastructure to be one of the key investment attractions of 2012.
While these funds, in particular the investment trusts, are usually sought out by income seeking investors, Simon James, founding partner of wealth manager Gore Browne says they provide the potential for consistent long-term growth of around 6 to 8 per cent a year, which is good in the current low growth environment. Of course, it is also true that a high dividend paying investment enables you to reinvest the dividend which can tremendously boost the total returns.
The caveat with infrastructure investment trusts is that they all run at premiums to net asset value (NAV). But Mr James thinks they are still worth buying because of their link to relatively safe government revenues and generous yields. Not everyone agrees though. Iain Scouller, head of funds team at broker Oriel Securities, argues that these funds are too expensive: "We think the whole infrastructure sector is expensive, with many funds trading on sizeable premiums and further significant equity issuance at close to NAV is expected during 2012," he says. "We currently have the Infrastructure sector on a negative or reduce recommendation."
There are a number of open-ended infrastructure funds such as IC Top 100 Fund First State Global Listed Infrastructure, as well as CF Macquarie Global Infrastructure, JPMorgan Emerging Markets Infrastructure and Invesco Asia Infrastructure. The attraction of these funds is that they provide exposure beyond UK borders, tapping into regions such as the US and emerging markets. This also helps to reduce UK political risk - it is worth noting that UK Private Finance Initiative (PFI) and Public Private Partnership (PPP) schemes are unlikely to continue in their present form, although managers of UK infrastructure funds say that despite this there is still a good pipeline of new opportunities.
Many of the drivers of global infrastructure investment such as developing economies and urbanisation are also increasing the need for water. This is mainly driven by the need for agriculture to grow more food. Water is also needed for industrial use. With the world population set to increase from 7bn to 9bn over the next 40 years, the Organisation for Economic Co-operation and Development (OECD) expects water demand to rise by more than 50 per cent. This comes at a time when climate change may place a strain on water supply turning fresh water into one of the world's scarcest commodities.
Solutions to managing the competing demands of water’s heaviest users: farmers, energy producers and households, will be crucial, and companies which can help ease the strain on water resources are likely to do well. This includes companies involved with water recycling, efficient irrigation and water desalination. Asset manager Pictet, which runs a water fund, predicts the water services sector will sustain its current strong rate of growth of 6 per cent per year.
"For investors, this presents an attractive opportunity," says Pictet. "Much of the industry's expansion should come through the private sector. Private companies currently account for just 8 per cent of the global water services market but this figure is expected to rise to 21 per cent over the next decade, driven in large part by the outsourcing of water services worldwide. Having a stake in the companies that can help steer the world away from a water crisis can therefore be a rewarding endeavour for investors."
There are listed water utilities in the UK but to fully benefit from this trend you should have exposure across the globe, which also provides more geographic and sectoral diversity, helping to dilute the investment risks. Water investment risks include government intervention, in particular with utilities, and tariffs and taxation. Some water funds, meanwhile, invest in early stage businesses.
Exchange traded funds (ETFs) which track water companies include ETFX S-Network Global Water Fund, run by ETF Securities. This tracks the S-Network Global Water Index which comprises about 60 utilities along with about half of its assets invested in companies engaged in infrastructure and technology development. The ETF gets its return via a derivative swap (synthetic replication) rather than buying the underlying shares and has an attractive total expense ratio (TER) of 0.65 per cent.
Lyxor ETF World Water tracks the World Water Total Return Index, also using synthetic replication with a TER of 0.6 per cent.
IC Top 100 Fund Ecofin Water and Power Opportunities is an investment trust which invests in utility companies including those involved in electric power, water treatment and waste, natural gas, and energy transmission. More than 80 per cent of these are listed in developed countries. It has a TER of 2.37 per cent and trades on a discount to NAV of around 25 per cent.
Pictet's open-ended Water Fund meanwhile invests in water services stocks, combining conservatively managed utilities with companies that exhibit strong long-term growth potential, aiming for a risk-return profile similar to global equities. It has a TER of 1.91 per cent.
For a more diversified play, WHEB Sustainability Fund has a third of its assets in each of climate change, water and demographics and comes with a TER of 1.75 per cent.
• Smaller companies
Smaller companies tend to grow faster than larger companies and over the last three years the top performing investment trust sector has been global smaller companies. Among open-ended funds the leading sector has been UK smaller companies. Smaller companies have also done particularly well over the last few months.
Smaller companies outperform when the economy is growing and rallies as investor confidence grows. But with the potential for stronger growth comes greater risk. Smaller companies are more volatile and can experience massive share price falls, as the sector tends to underperform when the economic outlook is weak.
Another risk is that having performed well recently the run for this sector is over. But small-cap specialist investors are reasonably optimistic going forward. "A return in confidence and optimism in the Eurozone at the beginning of this year following a period of exaggerated bearishness at the end of last year, together with a bounce in mergers and acquisitions (M&A), should create a favourable environment for European small and mid-cap stocks to perform well from current low valuations," says Nick Williams, manager of the Baring Europe Select Trust. "Small and mid caps in the Eurozone were hit particularly hard last year by negative sentiment in the markets but in the year to date have outperformed large caps."
Meanwhile US small cap stocks have benefited from the recent revival in the market (see this week's fund tip). "Small-cap US companies are relatively insulated from the events in Europe based on the majority of their revenues and operating profits being sourced domestically," says Christopher Berrier, co-portfolio manager of Brown Advisory's US Smaller Companies Fund. "Many believe that several downside risks have come off the table, so small caps have done well, as they traditionally do."
But it is still hard to know where the market will go and as this area tends to outperform over the long-term, it is worth committing for a significant length of time. Mr James suggests putting your money with a good smaller companies fund manager, especially as this is an under-researched area in which active managers can add value. He likes the BlackRock Smaller Companies investment trust which can be bought at a discount of more than 16 per cent, and Standard Life UK Smaller Companies investment trust on a discount of around 9 per cent, run by highly regarded manager Harry Nimmo. This trust's 12 month average discount is only -1.45 per cent and sometimes it trades at a premium, so this could be a good opportunity to get in.
Alan Brierley, investment trust analyst at Canaccord Genuity, has an overweight recommendation on Aberforth Smaller Companies. This investment trust's performance has struggled over the past few years because its managers are value investors - research by the London Business School has found that over the past five years growth has outperformed value by 10 per cent each year. However Mr Brierley argues that this is now turning and that since the end of November Aberforth’s NAV total return is 32 per cent, outperforming the benchmark by 8 per cent. This trust is on a discount to NAV of around 16 per cent.
On the open-ended side, Mr Lowcock's top pick is Old Mutual UK Select Smaller Companies.
If you are investing globally, F&C Global Smaller Companies Investment Trust recently won the award for Best Global Growth Fund at the IC fund awards. Other options include Invesco Perpetual Global Smaller Companies and McInroy & Wood Smaller Companies Fund.
For regional exposure, you could try Montanaro European Smaller Companies investment trust or F&C US Smaller Companies investment trust. For open-ended exposure Mr Lowcock suggests Threadneedle European Smaller Companies.
Short-term concerns about China aside, the long-term case for emerging markets remains intact which means most investors should have an allocation to this area.
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Source: Morningstar, *Ecofin.
Performance data as at 13 April 2012
Source: Morningstar, **Pictet.
Performance data as at 13 April 2012
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