Building a growth portfolio to meet your needs

Work out your risk appetite

A large factor in your asset allocation should be how much you can comfortably afford to lose if equity markets fall. Financial advisers refer to this as your capacity for loss – your ability to withstand a fall in markets and still be confident of meeting your goals. The shorter your time horizon, the less time you have to recover from any big falls in equity markets and so, typically, the lower your capacity for loss. As a result, you should take less risk. The longer your investment horizon, the more investment risk you can take. One way to work out your capacity for loss is to think about the impact a potential market fall of 20-30 per cent would have on your ability to achieve your goal, suggests Adrian Lowcock, head of personal investing at Willis Owen. If the impact were to be significantly detrimental, you should shift your asset allocation to focus more on capital preservation and less on outright growth. For more on figuring out your risk appetite, read “How to assess your risk appetite” on the Investors Chronicle website or in the 6 July 2018 edition.

Decide equities allocation

Beating inflation should also be a key focus of any long-term growth portfolio, as rising inflation will reduce the purchasing power of your assets. Investing in equities is an effective way to hedge against inflation because good companies have the potential to increase profits, at least in line with inflation. And over the long term investing in equities has historically delivered positive returns. The 2018 Barclays Equity Gilt Study (EGS) revealed that UK equities have generated a real compound average return of 5.1 per cent a year over an 118-year period. Over a 50-year period they generated an average return of 5.6 per cent and over 20 years this was 3.2 per cent.

Over a more recent period, Willis Owen analysed the performance of the FTSE 100 over 10-year periods by looking at every 10-year period from February 1986 to August 2018 on a rolling monthly basis. The analysis showed that out of 265 discrete 10-year periods, on 250 occasions or 97 per cent of the time, the FTSE 100 delivered a positive total return.

However, in the short term equities can be volatile. So, if you are investing with a five to 10-year investment horizon, it is a good idea to include other assets such as bonds and property to reduce risk.

If you are investing for at least 10 years, many financial advisers think it is appropriate to have 100 per cent of your portfolio invested in equities because of their long-term performance. Especially as bonds, which have traditionally been a useful diversifier from equities, currently have very low yields. And in an environment of rising interest rates holding these assets could result in capital loss for some investors.

“I’m not a huge fan of bonds and haven’t been for a long time,” says Danny Cox, chartered financial planner at Hargreaves Lansdown. “For more cautious investors, having some strategic bond funds could be appropriate. But in the long term you should really go for equities as they have the greatest prospects of returns. Bonds by their very nature will provide a lower return.”

Kay Ingram, chartered financial planner at LEBC, says: “The medium and lower risk-orientated client portfolios we run are multi-asset as we would rather forgo returns than suffer the downsides [of volatility from equities]. But for investors who can take higher risk and are looking for long-term growth, our portfolios have consistently concentrated on equities.”

However, some investment commentators argue that it is worth having exposure to assets other than equities, even if you are going to invest for 10 years or longer.

Emiel van den Heiligenberg, head of asset allocation at Legal & General Investment Management, says: “You can afford to take more risk if you’ve got a 20-year horizon, but we would still be in a diversified portfolio which would include assets such as bonds and property. Using those you can create a portfolio with equity-like returns but with less risk than just equities.”

Mr Lowcock adds: “No matter what your timeframe or risk level, you should have a bit of exposure to a range of assets."

And David Liddell, chief executive of IpsoFacto Investor, suggests having some exposure to absolute-return funds. “Although they are not focused on full-speed capital growth, they will hopefully be a steady provider of returns] even if you get a big downturn in growth assets,” he says.

Ultimately, where you position yourself in this debate will depend on your attitude to risk and whether you view different asset classes, such as bonds, property and absolute-return funds, as useful diversifiers.

Investors should bear in mind that sometimes they may need to shift their asset allocation, especially if their capacity for loss changes due to redundancy, a significant pay rise, or divorce. And you should move out of higher-risk assets and into lower-risk ones the nearer you get to withdrawing the funds. If you are investing to pay off future university fees or to purchase a property, your asset allocation should focus more on capital protection to avoid losing what you have made the closer you get to your target. To de-risk your portfolio, you can increase your exposure to cash, bonds and perhaps absolute-returns funds.

Choose growth areas

If you have a longer time frame you can afford to have more in global equities, particularly in Asia and emerging markets, which are key areas for growth investors to hold.

“[With a long term] time horizon, you should be able to ignore the volatility in these markets,” Mr Lowcock explains. “In the short term, they can be incredibly volatile and even in the medium term they can be out of favour. But longer term, they are quite appealing due to their demographics and economic growth potential.”

Mr van den Heiligenberg also advocates emerging markets. “The problem is, at the moment, there are not that many cheap assets around,” he says. “Very little jumps off the page when we compare asset prices. But emerging markets are one of the very long-term opportunities and their assets are cheaper relative to developed markets.”

Among emerging markets, he particularly likes India due to its young population and ongoing programme of structural reform. Investors with several years to invest can also afford to invest in cheaper assets as they have a longer time frame for these assets to hopefully come good.

Mr Liddell suggests some exposure to UK equities for long-term growth investors, particularly as the market is highly regarded for its income generation. He explains: “Some of the best growth over the next few years will come from reinvested dividends, so you should have some UK equity income funds and use them to reinvest dividends.”

Examples of UK equity income investment trusts he likes include: Edinburgh Investment Trust (EDIN) and Temple Bar Investment Trust (TMPL).

Smaller companies, based either in the UK or elsewhere, also offer good growth potential. Although higher-risk, smaller companies tend to have higher growth potential than large companies. In addition, small-caps are often less well researched than large-caps, making it easier to come across hidden gems. Two funds Mr Lowcock likes for small-cap investing are: Liontrust UK Smaller Companies (GB00B8HWPP49) and Standard Life Global Smaller Companies (GB00BBX46522).

And if you are investing for several decades you may want to use a small proportion of your portfolio to get exposure to areas that are expected to be long-term themes. For example Mr van den Heiligenberg thinks robotics, the internet of things and artificial intelligence are likely to be important tech themes over the next 20 years. While Ms Ingram thinks some exposure to funds that invest with climate change and agricultural developments in mind is a good idea. Her firm holds Sarasin Food and Agriculture Opportunities (GB00B77DTQ97) in its most adventurous growth portfolio for exposure to these themes.

LEBC's balanced growth portfolio

LEBC's adventurous growth portfolio

Source: LEBC