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Cultivate growth in your Isa

Created:

9 March 2010

Updated:

11 March 2010

Written by:

Leonora Walters

The worst of the financial crisis is behind us, and most of the world's economies have emerged from recession. But growth, particularly in developed markets, still looks elusive. It seems as if we have swapped corporate problems for sovereign ones. However if you have an investment time horizon of five years or more, you cannot afford to ignore the superior returns you will obtain from higher risk, higher return assets.

Claire Evans, unit trusts marketing director at Legal & General, says: "Over the long term, savers who invest in the equity market can earn a potentially higher return than they may get by leaving their money on deposit. Savers may be missing out on equity market returns believing that these types of investment are only suitable for those with large sums to invest.

"Regular savers can take advantage of the potential for long-term growth in stocks and shares and benefit from tax savings by sheltering their money from capital gains tax in an individual savings account (Isa)."

Emerging markets for growth

Emerging markets, particularly Asian ones, have long proved popular with investors because of the simplistic, and largely incorrect, belief that their faster economic growth will result in better investment returns. However, Tim Gardner, fund manager of the Legal & General Multi-Manager Growth Trust, believes Asian shares outside Japan remain attractive and are not yet over priced, despite an appreciation over the last few years. Consequently, he is overweight these regions.

But investors have to bear in mind the greater volatility of Asian and emerging markets. "Consensus optimism about emerging markets does cause us some concern, and there is the possibility of exuberance leading to stretched valuations and a correction at some point in 2010," says Gavin Haynes, investment director at independent financial adviser (IFA) Whitechurch Securities. "But the long-term outlook is still positive and we see long-term investors as under-represented in this area. If you can stomach the volatility it is certainly an area to consider for your Isa."

He says you could invest between 20 and 35 per cent of the equity portion of your portfolio in emerging markets, but advises you keep this at the lower end at present given his concerns over a possible correction. Mr Haynes suggests the First State Global Emerging Market Leaders and Ignis Hexam Global Emerging Markets funds in this space which both boast strong performance records.

Justine Fearns, research manager at IFA, AWD Chase de Vere, favours a broad based fund such as the First State Asia Pacific Leaders, Aberdeen Emerging Markets or JPMorgan Emerging Markets. "These will provide adequate exposure to the BRIC (Brazil, Russia, India and China) economies, if these countries' stock markets provide value, and if not, these funds will seek value in other emerging markets."

For those prepared for the higher risk, Ms Fearns suggests Gartmore China Opportunities, but warns: "I would only advocate a small portion of your portfolio is allocated to a single country fund, and only if you have a higher risk tolerance."

UK opportunities

Gloomy headlines about Britain's debt burden and the slumping pound may put you off investing in the UK, but says Ms Fearns, it is still important to invest in your domestic market. "In the short-term we think growth will be subdued, so we are more positive on equity income," she says. "For an investor with a balanced risk profile I would suggest an allocation of around 25 per cent to UK equities, more skewed to equity income and value. Newton UK Opportunities (see profile) would be good for current conditions because it has a slight value bias."

"Equity income funds should have a core part to play in any growth investor's portfolio," adds Mr Haynes. "Dividend growth has been a massive driver of share price performance and reinvesting dividends can have a hugely positive effect in increasing the compound return."

These funds also offer a ready income stream should you decide that you want to stop re-investing and take an income.

"We still hold 25 to 30 per cent in our stock market growth portfolios in equity income and stock-picking funds which can provide added value even if the stock market trades in a range," says Mr Haynes.

Jonathan Fry, director of wealth advisers, Jonathan Fry, suggests a higher allocation of between 30 and 40 per cent to the UK, recommending funds such as Marlborough Special Situations and M&G Recovery. These funds have a bias to small and mid-caps, but a flexible enough mandate to move away from these if required, so they could also be suitable for more cautious investors.

"Given current challenges to European economies we favour having greater exposure to BRIC economies and South East Asia," says Mr Fry. "Reduce the UK by 10 to 15 per cent and increase exposure to economies with greater growth prospects."

UK advocates also point to the fact that many UK companies generate a high proportion of their earnings overseas and are not very exposed to the UK economy, in particular large-caps. "I now get a lot of my UK exposure in funds where 60 to 70 per cent of the earnings come from overseas," says Mr Gardner, who is underweight the UK. "If it were not for that I would hold even less in the UK."

Small is beautiful

While large caps can benefit from overseas earnings, UK smaller companies can provide excellent opportunities for growth investors because they are usually at an earlier stage in their life cycle than larger companies. But these companies are typically more exposed to the domestic economy and in difficult economic conditions it can be harder for smaller companies to fund operations, making the area higher risk. That said, there are funds in this space boasting long-term out performance such as the BlackRock UK Smaller Companies and Standard Life Investments UK Smaller Companies funds.

On the investment trust side Mr Haynes recommends the Aberforth Smaller Companies as it currently is on a 15 per cent discount to net asset value (NAV). This is the by far the largest smaller companies trust meaning it is more liquid than some of its smaller peers.

Artemis Alpha investment trust also focuses on mid and small caps and has a good track record, according to Stephen Peters, investment trust analyst at Charles Stanley.

US plays

Another developed market that growth investors cannot ignore, according to Ms Fearns, is the US. "This is still the biggest market in the world and you would be foolish to miss the opportunities which can be found here. We have increased our allocation to neutral as we anticipate dollar strength. An investor with a balanced risk appetite could have an allocation of around 10 to 15 per cent to the US."

She suggests the Threadneedle American and American Select funds (see profile), both of which have done well.

Mr Haynes is also becoming more positive on the US stock market, as it is home to a number of high quality, world leading companies which could deliver superior growth because of their high exposure to faster growing regions, their industry or superior technology. He suggests a large cap biased stock picking fund such as Martin Currie North American Alpha.

Given that the US is a mature market which can be difficult to outperform, some advisers suggest you consider a tracker fund to get US exposure into your Isa.

Investors with smaller portfolios can get US and other overseas exposure via a global equity fund such as M&G Global growth, or the Scottish Mortgage investment trust which is large and liquid fund with good global exposure.

Value in Japan

There is a growing view among some advisers and industry players that now is time to reallocate some of your funds to Japan. "While the Japanese stock market remains an enigma I believe that this market could be the surprise package of 2010," says Mr Haynes. "Valuations, exposure to Asian growth and political change all provide an argument to add some exposure at current levels. We have been adding Japanese exposure across our portfolios for investors seeking long-term growth.

"I believe a weakening of currency could be the catalyst to make this market outperform. I favour Neptune Japanese Opportunities, which has a focus on exports and a hedging policy that will be positive for UK investors if the yen does weaken."

Stuart Fowler, managing director of wealth advisers, No Monkey Business, says few UK managed funds have managed to outperform the Japanese market so an exchange traded fund (ETF) could be a better option for this space. However, with specific areas such as exporters set to outperform, a managed fund could do better, and you can find a wider choice of out performing Japan funds domiciled offshore.

Strong long-term performers include JOHCM Japan, run by experienced Japan manager Scott McGlashan.

Don't dismiss Europe

Another area to exploit value is Europe, according to Mr Fowler. This region has been unpopular with investors so provides neglected and overlooked opportunities on good valuations. But a country or region's GDP growth does not necessarily mean markets will go that way, with the performance of European listed multi-nationals, for example, more correlated with global trade.

"A lot of the dynamism in Europe is about producing goods and selling them abroad to areas including the emerging markets," says Marcus Brookes, fund of funds manager at Cazenove Capital Management. "For example German engineers are selling into China while European luxury goods firms are participating in the emergence of the Asian middle class. We seek funds with flexible mandates which can seek the best companies and sectors." Funds he holds include Neptune European Opportunities and Cazenove European.

Investors may be put off Europe given the recent problems of economies such as Greece, Spain, Portugal and Italy, but an actively managed fund can allocate away from problem areas, while over the short term the weakening of the Euro as a result of problems in these countries benefits exporters in stronger northern European countries.

Stockbrokers and advisers, Oriel Securities recently reported that many European investment trusts are at wide discounts to net asset value following the weakness of sterling against the euro and some upward moves in European markets. Funds which look cheap on a discount basis include the Henderson Eurotrust on a 9.1 per cent discount and Gartmore European on 7.2 per cent.