You don't need to shoot the lights out to meet your objectives

“I left university debt-free and will hopefully be in a position to ensure that my children do too,” says Joshua’s dad. “We will pay for some of my children’s university costs if necessary, but would prefer to build up their junior Isas over the next two to three years to cover them – rather than having to fork out a lump sum to meet shortfalls in around 10 years.

"My daughter is age 14 and has an almost identical Junior Isa to Joshua, but it has already grown to £41,122 so I hope we have most of what she will need. But we want to ensure that my children get an equal amount to each other so I am prepared to make up the difference for whichever of them has less at, say, age 21.

"We and their grandparents have made regular contributions to their accounts, al though we haven’t used each of their full junior Isa allowances each year. We could contribute the maximum amount possible each year [£4,368 per junior Isa for the 2019-20 tax year] to both their accounts as we are in a comfortable financial position, but I’m hoping that we don’t have to. Perhaps selfishly, I’m hoping to retire early in the next two to three years – I am 51 – but I want to ensure my children’s Junior Isas are sufficiently funded before I do.

"As Joshua is only 11 years old his Junior Isa has plenty of time to recover from any downturns. We have yet to decide whether we will cash in his Isa when he is in university, or take out student loans and then cash in his Junior Isa to pay them off at the end. I guess it will depend on the state of the markets and the size of his Isa nearer the time.

"I have been investing for 33 years and like to run a broadly diversified portfolio. Joshua's Isa includes high-growth funds, alongside a few income funds to cover investment platform fees without having to realise investments and as a source of fresh funds to reinvest. I don’t like direct shareholdings because I don’t see the need to take on single-stock risk.

"During the past 12 months I sold Artemis Global Income (GB00B5N99561) and Biotech Growth Trust (BIOG), and bought BNY Mellon Global Income (GB00BLG2W887) and HarbourVest Global Private Equity (HVPE). But I tend to take a buy-and-hold approach rather than churning holdings and chasing trends, so I am not planning to add many new investments to Joshua’s portfolio. Rather, I will top up existing holdings by reinvesting dividends and new money. But I might consider a robotics fund as I like the idea of a small dabble in this area.

"Joshua also has NS&I Premium Bonds worth £100 – a gift from his grandparents – and £40 in his piggy bank!"

Joshua's Junior Isa

NONE OF THE COMMENTARY BELOW SHOULD BE REGARDED AS ADVICE. IT IS GENERAL INFORMATION BASED ON A SNAPSHOT OF THIS INVESTOR'S CIRCUMSTANCES.

THE BIG PICTURE

James Norrington, specialist writer at Investors Chronicle, says:

You have nearly £33,500 invested and several years before you plan to access the money. So if you add some money to your son's junior Isa each year, even with only a modest rate of return it’s likely that he will have enough money to leave university debt-free. Albert Einstein described compounding as the eighth wonder of the universe and, just by staying invested, making contributions and reinvesting dividends, you can take advantage of this mathematical phenomenon and end up with a sizeable portfolio.

It's great that you have started investing for your son when he is so young, but it doesn’t mean that you have a long investment horizon as your first important objective is paying for his higher education, maybe from as soon as seven years’ time. This may seem a long way off, but it might not be long enough to recover if there is a serious equity bear market in shares. It took the FTSE 100 fifteen years to recover to its highs of before the 2000 dotcom crash, and many of the funds you invest in have far more concentrated strategies than a FTSE 100 tracker in risky areas such as emerging markets and smaller companies.

If your objective was saving for your son's retirement in over 50 years' time, you’d be perfectly placed to take advantage of the risk-reward trade-off to ride out downturns in pursuit of a higher long-run rate of return. However, as you’ll be liquidating some of this portfolio in less than a decade to pay for tuition fees, accommodation, living expenses and leisure, you need to mitigate the risk of having to crystallise portfolio losses in a market downturn.

Historically, the best way to diversify the risk of equity markets was by investing in bonds. But because all asset prices have been inflated by loose monetary policy since the 2008-09 global financial crisis, it's less likely that capital gains from quality bonds will offset equity losses in a sell-off. But it's still worth including government bonds in your son's junior Isa to protect against the worst drawdowns in shares.

HOW TO IMPROVE THE PORTFOLIO

James Norrington says:

Bearing in mind the risk of a stock market downturn, there are a couple of fundamental questions to consider. As you have enough time to benefit from compounding, are you taking more risk than you need to and is that risk likely to be rewarded? Also, are you investing in the most cost-efficient way, given the likelihood that the more esoteric funds will deliver superior performance compared to the market?

You don’t need the portfolio's performance to shoot the lights out to meet your objectives, so you could have a more modest asset allocation strategy. A balanced portfolio might comprise 40 per cent bonds and 60 per cent equities. Your son's Isa is mostly invested in active funds with concentrated strategies and higher fees. Some active managers add value, but they have periods of underperformance and can be expensive. So to manage risk and reduce costs, you could split the equity allocation between a cheap global tracker fund, and two or three managed funds you believe in, for example global large-caps, smaller companies and emerging market funds. The boom in passive investing over the past decade may have created value discrepancies that skilled managers can exploit, so by mixing active and passive funds you could benefit from this.

For your bond allocation, there are very cheap exchange traded funds (ETFs) available for less than 10 basis points a year – a basis point is a hundredth of 1 per cent. These are a cost-effective way to invest in liquid short-dated bond indices, and would be a good way to invest in US Treasuries and UK gilts. Your bond allocation could also include an active fund run by skilled experts who invest across different maturities, credit ratings and regions, and in both government and corporate issuers, to achieve a higher return than safer government debt.

Tom Dawson, investment manager at Redmayne Bentley, says:

Because you started to invest for your children at such young ages you will put them in very good financial positions in the future. To maximise the potential for returns over the longer term, junior Isas should hold investments with certain key qualities or characteristics. These include quality businesses with resilient balance sheets that generate high returns on capital, and have a focus on sectors with strong long-term structural tailwinds. You should also not be afraid of being overweight small and mid-sized companies. So your son's junior Isa largely conforms to how I think it should be invested.

But about quarter of it is in emerging markets and Asia Pacific. There are well established arguments for having broad exposure to these regions, such as high rates of economic growth compared with western economies, and the increasing proportion of the population classed as at least middle class, which has increasing potential to spend. 

See this week's Big Theme for more on this

However, the portfolio’s exposure to these regions is pushing the upper bounds of what I feel is prudent and, with most of these markets, there is ample opportunity to benefit from these trends via funds invested in western markets, which have deeper pools of capital and higher standards of corporate governance.

That said, China increasingly seems to be an exception to this as it is a market where domestic businesses have the advantage. You have some exposure to China via iShares Emerging Markets Equity Index (GB00BJL5BW59), but consider selling one of your other investments focused on the broader region and reinvesting the proceeds in a fund that increases the Junior Isa's weighting to China’s economy. Options include Fidelity China Special Situations (FCSS,) which is trading at a discount to net asset value of about 9 per cent. Or consider iShares MSCI China A UCITS ETF (IASH), which has a lower ongoing charge but was only launched four years ago.

Robotics is a difficult theme to gain pure exposure to, although you could buy an ETF such as iShares Automation & Robotics UCITS ETF (RBTX). But active management is preferable in this space and you hold Smith & Williamson Artificial Intelligence (IE00BYPF3314), which appears to have a broad enough mandate to be able to invest in this theme.

Perhaps the best way to benefit from robotics is to hold another fund alongside this one, such as Allianz Technology Trust (ATT). It has a strong track record and flexible mandate so could have exposure to robotics-focused companies. This trust's managers are based in San Francisco and say that their proximity to Silicon Valley, where significant robotics and artificial intelligence research and development are located, makes them more likely than most to notice new technology investment opportunities quickly.

Rob Morgan, pensions and investments analyst at Charles Stanley, says:

It looks as though your son's junior Isa has got off to a pretty decent start. It's well diversified, but not to the point that it waters down long-term growth potential. Your timescale also means that the portfolio has plenty of time to recover from any downturns, so a focus on equities seems sensible. 

I like the bias to smaller companies because while these are more volatile they are likely to provide greater long-term growth potential. And investing in funds rather than individual stocks is prudent as these help to achieve an effective and low-maintenance portfolio.

Specialist robotics funds are maybe too much in vogue right now, although there are some important structural drivers, such as a shrinking workforce due to an ageing global population, rising labour costs, falling production costs of robots and consumer demand for customised goods at mass-produced prices. But if you wish to add a small holding in this area, bearing in mind that it is likely to be volatile, L&G ROBO Global Robotics and Automation UCITS ETF (ROBG) is a reasonably low-cost, passive way to do this. This ETF offers exposure to traditional industrial robotics hardware, and companies that are developing the latest technologies and software in robotics, and deploying those technologies into new applications.

Your son's Junior Isa does not include any funds dedicated to European equities - are you are deliberately underweight this area? Although the global funds have some exposure to this region it would be the most obvious area to add to balance the portfolio. There’s quite a lot of negative sentiment at the moment because US President Donald Trump may start a trade war with the European Union (EU), perhaps imposing tariffs on EU food and cars. However, shares listed on European markets have underperformed substantially to reflect this weaker outlook, so at some point it may be worth being more positive on selected companies and sectors.