Time to inject some growth

The consensus view

The consensus view is that economically, the West has some pedestrian years ahead of it. Once the stimulus packages have run their course, there will remain a protracted period of below-average growth as consumers, businesses and governments work off their huge debts. This pedestrian growth will restrain profitability and, once this relief rally is over, stock market gains.

In this low-growth, low-interest-rate environment, you should concentrate on companies capable of growing without a strong economy. We’ve had a good run by cyclical companies recently including the banks, but perhaps the time is approaching for a move back into more defensive companies.

Accordingly, since I introduced my investment-trust-based growth and income portfolio in the Investors Chronicle (, 16 Oct) I have sold within the Income portfolio the iShares Sterling Dated Corporate Bond Fund ETF (SLXX). Bank corporate bonds make up around 50 per cent of this exchange-traded fund, and it has had a strong run following relief that the worst maybe over for the banking sector. I have moved the proceeds into a new ETF which strips out the bank issues. This was highlighted in a recent Bond of the Week column; it's the iShares Sterling Corporate Bond ex-Financial (ISXF). This ETF yields around 5 per cent and the 120 holdings have an average maturity of 13 years.

Portfolio performance year-to-date

* Benchmark for the growth portfolio is APCIMS Growth and for income it is APCIMS Income. For more on APCIMS portfolio rules see www.apcims.co.uk.

Emerging Markets come of age

But you'll have to do more than get their UK sector strategies right to achieve success in the coming years. In a low-growth environment, you'll increasingly have to look overseas for growth.

Most investors have the vast majority of their assets in developed markets, with only a small percentage in emerging markets, typically around 5-10 per cent. This remains the consensus despite the growing attraction of these developing markets. I think this will change over time. Those investors who beat the consensus in realising this will be rewarded.

As Dr Mark Mobius, manager of Templeton Emerging Markets Investment Trust, puts it: "The key is growth. Growth is higher [in emerging markets]. The most populated countries in the world are also the fastest growing." Growth rates in China, India, Brazil and many other emerging markets will continue to beat those of the western world by some margin.

In addition, these markets are now less risky for investors. They are no longer burdened by high levels of debt, corporate governance has improved significantly and there is greater political stability. Such factors help stock market valuations.

Go east

Policymakers in emerging-market countries are gradually realising they cannot rely on western consumption as much as they've done in the past. We're seeing a structural change. Those emerging markets which are driven increasingly by domestic demand and investment will do especially well.

And this is where the Far East comes in. Many emerging markets, but particularly in Asia, have young populations and high savings ratios, meaning they haven't been great spenders in the past. This may be about to change. Low interest rates are reducing the incentive to save, while cash-rich governments are investing heavily in infrastructure and social welfare projects. That could result in domestic spending increasing significantly.

In short, emerging markets are the world's new economic powerhouses. They account for around 10-15 per cent of the world's stockmarket valuation, yet account for about 35 per cent of global gross domestic product (GDP). This gap will narrow over time. Many investors are taking an unintentional risk by not having sufficient exposure.

Volatility will remain, despite the lower investment risks, but investors should embrace and exploit it. If volatility is a measure of risk then investors would always be underweight good opportunities. The debate is more about timing, and present valuation measures should not deter investors from building positions.

Other portfolio changes

Both my portfolios have been overweight emerging markets, particularly the Far East, relative to their respective benchmarks, which partly accounts for their outperformance in the year to date.

However, my intention is to gradually increase exposure further. To this end I have introduced Fidelity Asian Values investment trust (FAS) to both portfolios. FAS has one of the best short and long term performance records, and stands at around its average discount.

This addition has been partly funded by selling all the Henderson Far East Income investment trust (HFEL) in both portfolios. The Henderson trust has performed well this year but FAS should continue to produce better longer term returns given it does not have an income bias. The additional exposure has been funded by "top-slicing" Caledonia Investments in the growth portfolio and using some of the cash in the income portfolio.

Growth portfolio asset allocation

Summary of growth portfolio changes since October

■ Sell Henderson Far East Income (was 6%)

■ Reduce Caledonia Investments (was 10%, now 6%)

■ Reduce cash (was 1.5%, now zero)

■ Buy Fidelity Asian Values

Income portfolio asset allocation

Summary of income portfolio changes since October

■ Sell iShares sterling corporate bond ETF (was 6%)

■ Sell Henderson Far East Income (was 5%)

■ Buy iShares corporate bond ex-financial ETF

■ Buy Fidelity Asian Values