Come next April, whatever your age, you'll find an extra £3,000 in your individual savings account (Isa) allowance. Whether you split this between cash and stocks and shares or invest the lot, it's important to find the right home for your money.
Where this is will depend on a number of factors. "This will be dictated by your tolerance to risk as well as the length of time you have to invest," says Darius McDermott, managing director of Chelsea Financial Services. “If you’re saving for a mortgage deposit in five years time you should look to take less risk than if you were putting money away for your retirement in 20 years time. This is because over a longer time period your investment has more time to recover its value.”
Your other investments will also have some bearing on where you invest. If you’ve already built a portfolio of core holdings then look to spice things up with more specialist funds. Conversely, if you’ve picked the expert recommendations year after year then you probably need to go back to basics and put together a portfolio of core holdings that reflect your attitude to risk and your timeframe. “Take into account all your investments, not just your Isas,” says Jason Walker, senior manager at AWD Chase de Vere. “It’s your overall exposure that’s important so rebalance across your investment portfolio if it’s necessary.”
Assessing your attitude to risk can be more difficult but Mr McDermott recommends asking yourself a fairly straightforward question. “How would you feel if your investment dropped by 20 per cent overnight? If this doesn’t overly bother you then you can probably stomach more adventurous investments. But, if it does, take less risk. If the thought of losing anything is unpalatable then you probably shouldn’t be in stocks and shares at all,” he explains.
Depending on your risk profile, here are some fund types that might be suitable for your Isa.
Cautious
Fixed-interest funds are a popular choice for the more cautious investor. “Bond funds are particularly suitable for low-risk investors,” says Hugo Shaw, investment manager at Bestinvest. “And because they pay interest rather than dividends you benefit from the full tax credit in your Isa.”
Within the fixed interest sector there is a wide range of funds to choose from, offering different levels of risk and return. These range from low-risk government bonds or gilts through to higher-risk with the high yield corporate bonds where the risk of default increases. Mr Shaw recommends Fidelity Moneybuilder Income. This invests in sterling denominated fixed-interest securities and has a solid track record.
While fixed interest can deliver lower risk, many advisers recommend some equity exposure too. This increases diversification and, as the two markets perform differently, ensures that if one is flagging there’s potential for the other to hold up the fund’s performance.
With this in mind, Andy Parsons, advice team manager at The Share Centre, recommends Investec Cautious Managed. This has a maximum equity exposure of 60 per cent with the remainder sitting in fixed interest. “This fund launched in 1993 and has a very good track record. Its manager, Alastair Mundy, has been with the fund for nine years and is well respected in the industry,” explains Mr Parsons. “This combination of assets means that whatever happens in the market you should do ok.”
Mr McDermott takes this approach a stage further, recommending a multi-asset fund, CF Miton Special Situations. “The manager, Martin Gray, has been with the fund since launch in 1997 and over that time he’s produced some staggering annual returns,” he explains. “In 2008 when stock markets fell, this fund delivered a positive return.”
This has been achieved as a result of the fund’s ability to switch in and out of different assets including equities, fixed interest, property and currency, allowing it to sit out of the equity market when it was tumbling in 2008.
Another option that gives the fund managers more control over the fund portfolio is an absolute return fund. These aim to deliver positive returns in any market by switching between a variety of assets including equities, derivatives, commodities and property. “You do need to be sure you understand the fund mandate as some are more aggressive than others. I’d recommend the BlackRock UK Absolute Alpha Fund. In rising markets it will lag but it should achieve good steady growth over the long term,” explains Mr Walker.
Balanced
Sticking with home grown companies is one way to reduce risk and many advisers recommend a UK fund for a balanced, or medium risk, investor. Information on these companies is easily accessed and it can be reassuring to invest in companies that are well-known.
Both Mr McDermott and Mr Parsons plump for a UK fund with one of the longest track records going, M&G Recovery. Launched in 1969 it’s weathered more market slumps than many other funds and its investment strategy of picking UK companies that are out of favour is perfect in the current market.
Mr Parsons comments: “Due to the small company exposure this fund is possibly at the more risky end of where balanced investors might want to invest. However, it’s well positioned to take advantage of the opportunities that will arise over the next 12 to 18 months as the economy recovers. Additionally, it’s a solid performer, AAA rated by Standard & Poor’s, and there are very few funds that are even close to celebrating their 40th anniversary.”
As well as considering the performance, Mr Shaw also looks at the length of time the manager has been with the fund as an indicator of stability. In light of this he recommends Artemis Income. “This is a solid, UK equity income fund run by an experienced manager,” he says. “The dividend yield is healthy and there is good potential for capital growth.”
Broader exposure is also an option for the medium risk investor. By spreading your investment across other countries you increase diversification, which can help to reduce risk.
To achieve this Mr Walker recommends a global multi-manager fund, Thames River Distribution Fund. “You do need to be careful when selecting multi-manager funds as some don’t deliver any value for the extra expense but this isn’t the case with this fund. It’s managed by Gary Potter and Robert Burdett, who used to be at Credit Suisse, and it looks for more unusual investments, such as unregulated and closed end funds, that don’t tend to end up in other multi-manager funds,” he explains.
Adventurous
For the more adventurous investor emerging market funds are a popular recommendation. “Emerging markets have grown their GDP [gross domestic product] at double the rate of advanced economies since 1995,” says Mr McDermott. “Most investors are underweight in emerging markets but there are definitely opportunities for those prepared to ride out the volatility.”
His recommendation is the Ignis Hexam Global Emerging Markets fund. “This can invest in any emerging market and as well as having some very good long-term performance has lower volatility than many funds in the sector,” he explains.
Another popular choice is the First State Global Emerging Markets Leaders. As well as outperforming the sector over longer time periods, this fund wins favour by having an office in the Asia Pacific region.
Mr Shaw throws another option into the emerging market investment ring, Aberdeen Global Emerging Markets Smaller Companies Fund. Although this combines two potentially high-risk investment areas - emerging markets and smaller companies - Mr Shaw says the management is very strong and very experienced in these areas.
Parsons goes for another fund from First State, First State Asia Pacific Leaders. Although not specifically an emerging markets fund, it can invest in emerging markets in the Asia Pacific region and, at the end of August, its portfolio included 32 per cent in China, 17 per cent in South East Asia, 11 per cent in Korea and 7 per cent in the Indian Sub-Continent. “It’s a huge fund with very broad exposure to this region,” he explains. “Additionally I like the fact that the fund analysts are based locally. These are difficult regions to get to grips with and it is much easier to do this if you’re based in the area.”
Emerging markets aren’t the only high octane area of investment. Mr Walker recommends a North American fund, Martin Currie North America, to those prepared to take more risk. “We’re still not out of the recession but when this happens North America normally leads the way. It reacts quickly and aggressively to changes in the economy so, although it could be a bumpy ride, it does tend to recover faster,” he explains.
Structuring your portfolio
Whichever type of investor you are, and however many of these fund areas you select, a well structured portfolio will ensure your investments aren’t at the whim of any one market. “You should have exposure to every asset, regardless of your risk profile and investment objective,” says Matt Pitcher, senior wealth adviser at Towry Law. “A broad portfolio, with asset allocation adjusted to suit your requirements and appetite for risk, will deliver more consistent performance. When one area is performing badly, you can almost guarantee that another will perform well. This ensures you don’t miss out on performance.”
For example, while an adventurous investor would look to have more exposure to overseas markets, a cautious investor would limit these holdings and increase their portfolio’s weighting in fixed interest.
As well as getting your asset allocation right, diversification is also important. “I wouldn’t go for just one fund in each area,” says Mr Parsons. “Diversify the management style too and have one or two managers in an area. This gives you further diversification and guards against one manager’s style not fitting the market conditions.”
But although diversification is a good thing for an investment portfolio, there comes a point where it can be too much of a good thing. Mr Shaw says the ideal portfolio is made up of between 15 and 20 funds. “They should all give you exposure to slightly different things. There’s no point having 10 European funds that all do the same thing,” he adds.
As a starting point he suggests investing in core funds that invest in the UK, bonds, international and property. “These are good solid parts of a portfolio. Once these are in place you can add more interesting funds that suit your risk profile,” he explains.
It’s also essential to regularly review your portfolio. As different markets grow at different rates even the most well structured portfolio can become flabby. Trimming back the excesses and increasing exposure to areas that have underperformed can improve returns. “Over time the asset allocation in your portfolio will change to reflect different returns from your investments,” says Mr Pitcher. “If you regularly realign your portfolio you will be taking advantage of one of the most important rules of investment - buy low and sell high.”
