Best Isa funds for long-term growth

Emerging markets argument

A good starting point could lie in the well-rehearsed argument favouring funds with exposure to emerging economies. Despite emerging stock markets sharing in the pain of the global slowdown, the continued industrialisation of emerging giants such as China and India remains a pretty sound bet.

While events of the past six months may have proved that the developing world is not decoupled from the West, it is important to differentiate between the structural slowdown in developed economies caused by exorbitant levels of debt and the cyclical slowdown taking place in emerging markets largely driven by de-leveraging in the West.

Meera Patel, senior analyst at Hargreaves Lansdown, adds that while emerging markets represent four fifths of the world population, three quarters of its land mass, two thirds of the world’s foreign exchange reserves and contributes 61 per cent towards global growth - they only make up 9 per cent of the world stock markets, making the growth opportunities enormous.

There are a few emerging market funds worthy of a place in your Isa. Jason Walker, senior manager at wealth managers AWD Chase de Vere, rates the First State Global Emerging Market Leaders Fund with its impressive five-year performance of 83.2 per cent. He believes fund manager Angus Tulloch’s cautious approach has paid off with the fund managing market volatility and downside risk much better than its competitors. Mr Walker adds that a more aggressive alternative can be found in the Martin Currie Emerging Markets Fund which is a good complementary holding alongside First States’ Fund.

Glyn Williams, investment analyst for independent financial adviser (IFA) MAC financial advice, says investors confident of their timing should look to the Allianz RCM BRIC Stars Fund while those less certain should consider the Lincoln and First State Funds as sound long-term growth opportunities.

Another sound option is the Aberdeen Emerging Markets Fund, which boasts a performance in excess of 50 per cent over the past three years.

Alternatively, investors can access exposure to emerging markets via an exchange-traded fund (ETF). Investors Chronicle recently tipped the iShares MSCI Emerging Markets ETF as a cheap entry to attractive emerging markets. Lyxor also has various ETFs offering access to each of the BRIC (Brazil, Russia, India and China) economies.

Seek out absolute returns

As markets continue to see-saw, many IFAs argue that investors should be seeking out assets which deliver absolute returns that are not market driven. In this regard, absolute return funds with their promise of delivering positive returns regardless of market conditions seem the obvious answer. However, the sector has continually come under fire for failing to live up to the promise of its name.

The ineptness of many absolute return funds to deliver what they pledge has largely been put down to the different investment strategies followed. Despite their common goal of beating cash, some absolute return funds focus on a single asset class, such as bonds or cash, or are geographically specific for instance concentrating on the UK market, while others invest globally in all available asset classes, including alternatives such as commodities, private equity and currencies. There is also a breed of absolute return fund which reduces risk by shorting shares.

Short selling forms part of the BlackRock UK Absolute Alpha Fund's investment approach. Managed by Mark Lyttleton since its launch in April 2005, this fund is a firm favourite on IFA radars. Andy Gadd, head of research at IFA Lighthouse Group, explains the three strategies available to Mr Lyttleton. "He can use traditional long and/or synthetic short positions in various stocks where he has a strong conviction that a particular stock will rise or fall in value. However, the biggest part of the portfolio is invested in pair trades. Pair trades is a strategy that invests in a combination of a long and short positions often to neutralise an element of market risk. The long and short positions in the pair trades are equal which means the combined investment has a net market exposure of zero. It is this that gives the fund its very low volatility compared with the market.

"The final strategy is simply cash. Mr Lyttleton has the freedom to invest up to 100 per cent of the portfolio in cash. Cash, or cash-like instruments, will also principally be used to cover open derivative positions."

While Mr Lyttleton's low volatility approach served the Absolute Alpha Fund well prior to market meltdown, the fund has fallen into negative territory over the past year. However, Mr Gadd argues that despite the fund not being in line with its objective, if you look at the three-year figures and compare the fund's recent performance with the significant falls witnessed in the FTSE100 and All-Share indices, it is still a good long-term growth opportunity for the more cautious investor.

A fund which adopts a more aggressive investment approach than the BlackRock Absolute Alpha Fund is the CF Octopus Partner Fund. Launched in March last year, fund manager David Crawford steers aware from the pairing approach to look for mispriced stocks to which he then applies the long-short technique.

While the Octopus Partner Fund holds more risk and hence greater volatility, the new kid on the block's strategy seems to be paying off. The fund is up over 35 per cent since launch, and 7.5 per cent in January alone. "As you would expect this fund is receiving increasing amounts of attention from IFAs and looks set to grow over the coming months. However, it is still under £25m in size which gives fund manager David Crawford lots of manoeuvrability to take advantage of market opportunities," says Mr Gadd.

Bet on biotech

Investors who err on the side of caution could look towards the healthcare sector, specifically asset classes such as pharmaceuticals and biotechnology for steady long-term delivery.

While utilities and financials nose-dived, pharmaceuticals and biotech equities managed to outperform the FTSE 100 over the past year. Tim Collyer, head of investment solutions at Falcon Group IFA, believes there is a long-term growth story to be found in biotechnology. “While this is potentially subject to legislation it is an area where individuals are prepared to spend money and put pressure on governments to spend money. While governments will inevitably try to cut costs, the news agencies provide stories of individuals in distress as a result of policy. Few politicians have enough friends to be able to ignore the situation for long.”

Top biotech performers in this sector were the Axa Framlington Biotech Fund with a return of 28.4 per cent over the past year and the Franklin Biotechnology Fund, which managed a performance of 25.7 per cent during the same period. Interestingly, L&G and several other asset managers had healthcare funds but dropped these during the bull market.

Alan Brierley, head of investment company research at Collins Stewart, predicts the downturn to be much deeper and longer than the recession of the early 1990s and against this backdrop expects the defensive earnings characteristics of the healthcare sector to continue to command a premium.

Mr Brierley likes the Finsbury Worldwide Pharmaceutical Investment trust, one of Investors Chronicle's investment trust tips for 2009, which invests worldwide in pharmaceutical and biotechnology companies with the aim of achieving a high level of capital growth. While mergers and acquisitions (M&A) activity has virtually dried up in other sectors, the pharmaceutical industry is still enjoying some action. "Fund manager Sam Isaly expects continued M&A activity and underlying valuations which are at historically low values to underpin further outperformance," says Mr Brierley. The company has a discount control mechanism with a target level of 6 per cent and has purchased around 25 per cent of its shares since the beginning of 2007.

Given the sector performance of 9 per cent, biotechnology equities as a whole experienced much less buoyant growth during the past year and Mr Williams warns that historically biotechnology has been a pretty lacklustre sector which might not make it the best place to stay over the long term. However, Mr Brierley adds that while the sector did not go anywhere during the equity bubble of 2003 to 2007 it is an area which "has played major catch-up".

Commodities points to oil

While the recession might have taken its toll on the global demand for natural resources, fund managers, such Ian Henderson of the JPM Natural Resources Fund, believe that over the long-term the incremental demand from emerging economies will continue to put strain on the world's limited resources which will drive prices up once again.

Mr Walker agrees that commodities remain a fundamental theme for investors seeking long-term growth and says despite the poor performance of the JPM Natural Resources Fund over the last year, it remains one of the classic fund choices for exposure to commodities.

Other good bets are the JM Finn Global Opportunities Fund and M&G Global Basics Fund. With a background in geology to boot, Graham French, fund manager of the Global Basics Fund, played a key role in developing the investment strategy of the fund which bets on urbanisation and a burgeoning middle class in the emerging markets. Fund manager of the JM Finn Fund, Anthony Eaton, has a similar approach and has structured his fund to take advantage of urbanisation. Since its launch in January 2004 the fund has beaten the sector average by 5.6 per cent.

On the investment trust side, Mr Brierley picks out the BlackRock World Mining Trust, saying that despite a drop in performance over the last year, manager Graham Birch has done a very good job of adding value for shareholders in the 15 years running the fund. Mr Brierley however adds that he sees little hope of a turnaround for the commodities sector, expecting it to be anaemic for at least the next 12 months, after which he expects it to stabilise and move sideways.

Investors could however do well to set their sights on oil, given the view of Mr Henderson and other fund managers in the sector, that the current oil price will not be sustainable over the long term. Exposure to oil via ETFs - ETF Securities has a broad range on offer - could be one option to consider. Mr Gadd also suggests investors take a closer look at the CF Junior Oils Trust. Fund manager,Angelos Damaskos is confident that his holdings in businesses with limited debt should be successful in the long term and believes that the oil price will return to its long-term upward path.

Mr Gadd comments: “For those investors who feel that the oil price is currently undervalued and that there is an energy super cycle, this fund is a good opportunity for long-term growth. They need however at the same time to be prepared to accept the added volatility that comes with investing in medium to smaller companies.” A good fund to add to your Isa but, as Mr Gadd says, "certainly not one for widows and orphans".