Fund tips for 2012

But volatility creates opportunity and it is, in fact, the most risky assets - equities, particularly emerging market equities - presenting investors with an unusual opportunity to buy at more attractive prices. As Warren Buffett puts it: "Be fearful when others are greedy and greedy when others are fearful."

Investment themes

According to ING Investment Management (IM), three key themes will affect all asset classes in 2012: the ongoing crisis around the banking sector and the European Union Sovereign states, contagion - in terms of systemic risk, the global financial crisis and the implications of increased regulation and taxation and credibility around policymakers and their ability to develop the right solutions and obtain buy-in from voters and the market.

"These three c-themes highlight the need for investors to take on a more dynamic approach to their investment strategies…they need to be more responsive and opportunistic regarding their tactical asset allocation," says Eric Siegloff, global head of strategy and tactical asset allocation group at ING IM. He adds that it is important to take a more expanded view of asset class drivers and scenario analysis in order to translate macro views into your investment portfolio.

The most notable theme dominating the outlook for 2012 is the consensus that there is "no longer such thing as a safe haven". Cash will continue to yield little in the form of a return and, as credit risk continues to impact an increasing number of government bond markets, the list of investments classified as "low risk" will dwindle even further. "With real yields in negative territory in core markets, the potential for further gains is limited and the risk of significant loss is magnified. In this environment, investors seeking low risk assets need to look beyond government bonds. It is also likely that absolute return approaches remain popular," says Mark Burgess, chief investment officer in the senior investment team at Threadneedle.

Against this backdrop of crisis and uncertainty and with valuable input from analysts, fund managers and other experts, we have put together our predictions for 2012, cherry-picking the funds we expect to benefit from these unique and difficult conditions.

1) Stay with the US

While slower economic growth compounded by political events is on the cards for several economies, most notably Europe and the US, the two largest economic blocs in the world, the prospects for companies in these regions look a lot better.

"Company balance sheets are strong, many businesses are returning cash to shareholders via healthy dividends or share buybacks and valuations are very attractive on a range of measures relative to history and to most other assets. We are focusing on quality companies with experienced management and proven business models. In the tough conditions we foresee, the strong are likely to get stronger," comments Mr Burgess.

US companies, in particular, boast strong fundamentals which have largely been ignored by the markets. These include the emerging market exposure of many companies, strong competitive advantages thanks to the productivity and flexibility of the US workforce. Other advantages include a weak US dollar and the growing willingness of companies to pay dividends. (Read 'Boost your income with US yields' here).

Joanna Shatney, head of US large-cap equities at Schroders, says US corporates are well-positioned to drive earnings growth in a slow global growth environment and should outperform the US economy as earnings growth outpaces GDP. "I see room for corporates to take margins higher long term. Companies are underinvested and boast strong balance sheets, which offer earnings protection and provide an alternative of acquisitions, share repurchase and higher dividends."

Given these factors it might be worth upping your exposure to the US, although it should be noted that most active funds fail to outperform the US stock market consistently given its maturity and efficiency. As such this is a good area to use an exchange-traded fund such as db x-trackers S&P 500 ETF or ETFX Russell 1000 US Large Cap Fund - the Russell 1000 index tracks the 1000 largest US securities representing 92 per cent of the US market, making it a more comprehensive index than the S&P 500, which only accounts for 66 per cent.

If you're set on active management, Threadneedle American Smaller Companies is a good aggressive choice, especially considering that US smaller companies have outperformed their large-cap counterparts over the past 10 years. Tim Cockerill of Rowan Dartington explains: "Smaller companies have a different meaning in America to most other countries, they tend to be bigger. However, it is an area where the right companies can deliver substantial levels of outperformance. This is a well-managed fund with a solid record - it is a long-term play, but one that should prove profitable."

For a more cautious play have a look at Threadneedle American, managed by the same team as the smaller companies fund, but focused on large-cap stocks. It is a well-resourced team which follows a cautious investment approach. They draw on the experience of other teams within Threadneedle to provide a rounded view.

2) Yearning for yield

In light of a lacklustre growth outlook and to balance the tight fiscal policies being run in many markets, interest rates are set to be kept at historically low levels over the medium term. And, with government bond yields also offering little value, the search for yield will no doubt continue to be a major theme in 2012.

"We think this entire decade will be characterised by low growth. There are few places to hide from economic storms. Investors need to become very old-fashioned and participate in growing dividend streams over time, not capital growth," says Schroders' chief investment officer, Alan Brown.

Shares in large-cap, high-yielding companies with strong balance sheets, growing dividends, robust cash flow generation and proven capital allocation strategies are also likely to be in demand.

Dominic Rossi at Fidelity Worldwide Investment has similar views. He says: "While the prospect of capital appreciation is very low in developed equity markets, there are opportunities in income.

"In Europe, dividend yields are considerably in excess of their 15-year average and there are a number of equity funds which are targeted towards this particular income-yielding section of the market; the income offers a measure of protection to investors against further market volatility. These companies are typically large, robust household names such as Unilever, which may well prove to be a relatively safe place for investors to park some of their cash, when consideration is given to the mounting stresses in the banking system.”

There are a number funds offering exposure to European income opportunities such as the Jupiter European Income Fund, Newton European Higher Income Fund and Ignis Argonaut European Income Fund, all on attractive yields of between 4 and 7 per cent. But given the uncertainty around Europe's fortunes, these funds have not been delivering spectacular performances, and as such we're sticking to good old UK equity income funds. Our more aggressive choice is the Marlborough Multi Cap Income fund. Launched in early 2011, the fund invests in mid and small caps as well as larger companies and is managed by Giles Hargreave, who has excelled in managing smaller companies funds.

Our more cautious play is the Invesco Perpetual Strategic Income - this is the lesser known fund within the mighty equity income stable of Invesco. It draws on all the teams' work, ideas and processes and yet is only £80m in size. Last year we suggested the Trojan Income Fund, which turned out to be one of our top-performing fund picks, and we're sticking with it. Conservatively managed by Francis Brooke, the fund boasts by far the lowest volatility in the sector. It should therefore outperform in more difficult environments, but may lag markets in a strong rally.

3) Good bye G7 and hello G20

Emerging markets are not immune to what happens in the rest of the world and, given the uncertainty dominating global markets, these economies are also likely to see a slowdown in growth in the new year. However, the headwinds in emerging markets are cyclical in nature rather than structural, so the investment case for these markets remains robust on a medium- to long-term view.

The emerging world still benefits from far superior growth compared to the developed world, has relatively low debt and high foreign exchange reserves, and analysts predict that over the course of 2012, investors will begin to reward emerging markets' superior economic fundamentals and their better ability to recover from the slowdown in global growth.

"The contrast between emerging and developed markets will become even more conspicuous in 2012. Investors should be alert to buying opportunities in emerging markets that allow them to increase exposure at attractive prices. The long-term case for emerging markets is intact and the fact that we are in a 'two-speed world' in economic growth terms will only become more obvious," predicts Mr Rossi.

With emerging markets likely to deliver better economic and stock market performance in 2012 than their overly indebted developed counterparts, we are backing JPMorgan's Emerging Market Small Cap Fund as our aggressive choice for 2012. Performance has been strong and the fund is well-diversified both by holding and geography.

In the defensive camp, we are sticking with an existing fund tip - the First State Global Emerging Market Leaders Fund. First State has a conservative valuation approach that focuses on the long-term value within businesses, where there is quality management and solid business plan. It may not rise as quickly as others in bull markets, but it tends to outperform in difficult climates and in the long term the investment approach is likely to reward patient investors well.

4) Back to commercial property

With income a dominant theme of 2012, the commercial property sector cannot be ignored.

"The excess yield offered by UK commercial property over gilts is at historically wide levels and, although some areas of the property market are likely to suffer headwinds in 2012, the yield should be well underpinned," says Mr Burgess.

While the sector could be susceptible to further bad news from the UK consumer, we believe now might be an opportune time to add a property fund to your portfolio, especially if you're looking for income.

Bricks and mortar funds to be less volatile compared to those invested in property shares (although liquidity can be a problem as was illustrated during 2008). We like the L&G UK Property fund as our defensive choice. This is an open-ended fund invested in physical property which has been well managed. It is modest in size and holds cash at around 16-20 per cent to ensure liquidity isn't an issue. Threadneedle UK Property Trust is another defensively positioned fund with higher than average cash levels and a focus on higher quality properties in the UK. More recently, fund manager Don Jordison has become more upbeat on the prospects, as he feels prices are more distressed than in 2008 at the height of the financial crisis.

For those willing to take on a bit more risk, Aviva Asia Pacific Property has just nine properties in the fund making it very concentrated, although given the region it is focused on, it could deliver some good growth opportunities.