Two ETF portfolios for capital growth

Equities for capital growth

David Liddell, ‎CEO at online investment adviser IpsoFacto Investor, recommends an allocation of 55 per cent in UK equities and 30 per cent in overseas equities, split between emerging markets, Europe and Japan. The remainder of the portfolio is invested in cash, bonds and alternative investments. His portfolio would be suitable for a more adventurous investor who is happy with higher than average risk and aims for long-term returns of up to 7 per cent a year.

His core UK holdings are focused on the FTSE All-Share and FTSE 100 indices. Returns from the FTSE All-Share have been higher than the FTSE 100 over the past five years, but Mr Liddell suggests a mixture to give solid exposure to UK equities.

He recommends the SPDR FTSE All-Share UCITS ETF (FTAL) as a solid, low-cost core holding which has closely tracked the underlying index. In the year to date it has returned 8.6 per cent compared with 9.15 per cent for the benchmark. However, he suggests balancing that with the iShares Core FTSE 100 UCITS ETF (CUKX), which has tracked its index closely and has a low total expense ration (TER) of 0.07 per cent.

Despite concerns over a Greek exit from the euro and short-term UK volatility stemming from the general election, European equities are a key part of Mr Liddell's portfolio. He thinks Europe will probably produce the best returns among major markets over the medium term, in part due to an influx of quantitative easing (QE) liquidity.

He believes the emerging markets hold strong opportunities for growth, with China and India the strongest players. He has opted for Vanguard FTSE Emerging Markets UCITS ETF (VFEM), with a low ongoing charge of 0.25 per cent. The fund has 26.2 per cent exposure to China and 12.2 per cent exposure to India, where equities have risen rapidly over the past year. That high exposure to China does inject more risk into this emerging markets choice so the fund could be volatile.

Follow the money

Christopher Aldous, managing director at asset allocation and passive investment specialist firm Charles Stanley Pan Asset, also believes Chinese equities offer strong potential for growth. The market is dividing commentators, with fears over slowing GDP growth dominating. However, Mr Aldous says it is one of the most appealing regions within the emerging markets bracket for a diversified portfolio.

"I wouldn't want to be putting money into Latin America at the moment so I have a specific twist towards China, split between a broad China index and one focused on A-shares," he says. The latter are shares in mainland China-based companies that trade on Chinese stock exchanges. He has chosen db x-trackers Harvest CSI 300 ETF (RQFI) and HSBC MSCI China UCITS ETF (HMCH).

"China earnings growth is still around 10 per cent," he says. "People say China is too high a margin call but it's got tremendous growth."

He recommends "following liquidity" and central bank injections of QE to find the best equities in the world for growth. "Over the last four years or so until about the middle of last year, the right places to invest were the UK and the US, both recovering western markets driven by QE," he says.

"Now the world is being driven by Europe and to a certain extent Japan, driven by governments that want asset price inflation. This is about following liquidity and earnings growth."

In both regions QE has resulted in falling currencies and rising equity markets. That means that Mr Aldous is keen on hedging out currency risk in both Europe and Japan. In Europe he likes UBS MSCI EMU 100% Hedged to GBP ETF (acc) (UC60), which has returned 20.80 per cent in the year to date already. He also likes db x-trackers DR DAX ETF (XDDX) as Germany is a key beneficiary of the falling euro. Note this is an income unit as opposed to accumulating, so you would have to reinvest distributions yourself.

In Japan he opts for the iShares MSCI Japan monthly GBP hedged ETF (IJPH). Investors exposed to currency hedged products in Japan have taken home far higher returns over the past three years than those in unhedged share classes. However, whether that will continue to be the case is under debate. Mr Aldous feels it is worth taking out currency risk altogether and forgoing a potential upside if the yen appreciates unexpectedly against sterling.

He is less keen on the UK than Mr Liddell due to low earnings growth forecasts and has just 6 per cent in Vanguard FTSE 100 UCITS ETF (VUKE). "I fundamentally don't believe that some of the structural issues in the UK have been addressed yet. We don't have enough manufacturing, we are very vulnerable to weakness in sterling and to tax rises, which can crush profitability and consumer spending," he says.

Be careful with bond funds

Both Mr Aldous and Mr Liddell say bond funds are necessary but urge caution due to the uncertain nature of this asset class over the next 12 months. That is due to doubt over the timing of interest rate rises in the US and the UK, which impact longer-dated bonds and fears of a corporate bond bubble.

"You might ask do you need to hold bonds at all," says Mr Aldous, "but for a medium risk portfolio you do have to have them.

"Inflation expectations could pick up so I like having index-linked bonds, such as the iShares Barclays £ index-linked Gilts ETF (INXG). When there is a setback, longer-dated bonds tend to do quite well, when money floods into safe havens. I've chosen Vanguard UK Government Bond UCITS ETF (VGOV) as a hedge against weakness in markets."

To balance that out, he has also selected iShares £ Corporate Bond 1-5 UCITS ETF (IS15), which offers exposure to short- and medium-dated maturity segments of the sterling-denominated corporate bond market. The fund has closely tracked its benchmark since inception.

Mr Liddell says: "The potential for a mark to market loss on a bond fund is quite high at these low yields so I would have liked to have included an alternative total return bond fund, but I struggled to find something that fits the bill."

Instead he opts for db x-trackers db Hedge Fund Index UCITS ETF 3C (GBP hedged) (XHFG) and iShares £ Corproate Bond Interest Rate Hedged UCITS ETF (SLXH), which tracks the Markit iBoxx GBP Liquid Corporates Large Cap Interest Rate Hedged Index. The index aims to measure the total return of sterling-denominated corporate bonds in the Markit iBoxx GBP Liquid corporates Large Cap Index (underlying index) while hedging against underlying interest rate risk of sterling corporate bonds.

Reviewing asset allocation

Mr Liddell's portfolio is aimed at the long-term retail investor at the more adventurous end of the scale and says his portfolio aims for returns of around 6.4 per cent to 7 per cent. He says: "I'm assuming that from the UK market you take 3.5 per cent from yield and 3-3.5 per cent from capital gain."

Mr Aldous says his portfolio is aimed at returns of around 6-8 per cent on a long-term basis but emphasises the portfolio should be reviewed regularly. He says: "I think equity returns will be lower this year so long-term returns should be around 6-8 per cent and I expect it to be at the lower end of that this year, but it could be higher too. Our balanced portfolio has generated an 8 per cent return over six years so it is very do-able.

"But people have to remember that this is a long term-game and investors should review this portfolio in six months time to see if they want to flex back into more developed western markets if it looks like earnings growth is recovering in the UK."

He also urges a watchful eye over the property chunk of his allocation. He says it is "just too early to call the end of UK property, Asia property is a good long-term burn and Japanese property in particular is due a big move up."

But when it comes to UK property he says: "Investors must be quick to sell if they see any turn in the market or an unexpected rate rise, as listed investments react far more quickly to bad or good news."

Mr Liddell's portfolio is designed for investors holding for "five years minimum and ideally quite a bit longer than that". He says: "You might want to consider moving tactically between the core holding of the FTSE All-Share ETF and one tracking the FTSE 250. Ideally, you would also look at small-cap trackers."

We will review these growth portfolios every three months and gather suggestions from our experts about whether or not any tweaking is necessary.

You can see our two ETF portfolios for income in retirement here.

Reinvesting or distributing?

Mr Liddell says a major part of his choice was "looking for simplicity of management and finding ETFs that reinvested rather than distributed." But alongside that he says yield is an important consideration. He says: "Although it is a capital growth portfolio, history tells you that reinvesting yield is an important part of equity returns so going for a higher yield is still important."

Mr Aldous says: "Investors should aim to get accumulating units if they want a pure growth portfolio, although for tax purposes accumulating or distributing units make no difference to the investor."

David Liddell's growth portfolio

Christopher Aldous' growth portfolio