How to build a solid foundation for your ISA
Choosing core holdings is a crucial first step in every portfolio, says Helen Monks
Saturday 16 February 2008
Achieving the best returns is not about timing – it's about time. So says the old investment adage, and indeed, choosing the investments that form the long-term cornerstones of your ISA portfolio could make a big difference to your overall returns.
Core holdings, to give them their proper name, are substantial investments that tend to be bought early in your investing life for the express purpose of being held for a long time.
Core holdings tend to be characterised by a few things: they are usually more secure than other investment options, and they tend to have a history of fairly steady performance. "Typically, they are mainstream funds representative of their sector or asset class, and give clients a solid platform on which to build their portfolio," says Martin Bamford of the financial advisers Informed Choice.
Within this general brief, investors have a number of choices. Here, we assess some of the options available:
Funds of funds
One of the guiding principles when building a portfolio is asset allocation. This means deciding what proportion of your funds you want invested in, say, UK and global stocks and shares, in gilts and bonds, in cash, in property or in other asset classes.
Running a diverse spread of assets within your portfolio is an essential part of minimising risk. It ensures that you are not dependent on one asset to do well – and equally, if this investment performs poorly, a diverse portfolio may help shield you, as it will be made up of assets that are not impacted by the same economic forces as each other.
Some investors, perhaps with the help of an investment adviser, are happy to decide their own asset allocation. But if you would rather outsource the responsibility to someone else, then a "fund of funds" (FOF) could form the central plank of your portfolio.
An FOF invests in other funds rather than putting money directly into shares, bonds, or other securities. An FOF manager selects the best-performing funds, tapping into the expertise of lots of fund managers rather than just one.
Some financial advisers are fans of these all-in-one holdings, such as Andrew Priestley of Skipton Financial Services. "Around 90 per cent of investment returns are generated by getting asset allocation right," says Priestley. "Analysing the stock market is not something many people feel confident about getting right, and individuals often end up buying when costs are high and selling when prices are low.
"With a fund of funds, you get a mixed bag, including every major asset class, allowing you to hand over your asset allocation to an expert," he says.
Priestly likes the New Star Managed Portfolio and the Jupiter Merlin Income Portfolio funds of funds. The latter invests in equities, fixed-interest stocks, commodities and property, principally in the UK. Because a proportion of the fund is invested in fixed-interest securities, it should appeal to more cautious investors.
Some advisers, though, are unconvinced of the merit of the fund of funds concept. With FOF, investors essentially pay twice for fund management: both for the underlying fund management and for the manager who oversees all the funds.
"I haven't seen any evidence of the extra value that investors get from paying 2-2.2 per cent to buy FOF when buying the funds directly would cost 1-1.5 per cent. I'm yet to be convinced of the long-term value," says Bamford.
Trackers are funds aiming to achieve the same returns as a chosen share index, such as the FTSE 100.
Trackers try to mirror the returns of an index, so they do not involve paying a fund manager backed up by costly teams of researchers and analysts to ensure shares are bought and sold at the best time. Tracker funds simply invest in all of the companies in a given index according to their market value weightings. This extremely low demand on fund management expertise makes trackers among the cheapest ways to achieve a spread of equity investments.
"One of the easiest ways to maximise your returns is to minimise cost by not going for funds that are actively managed," says Jason Witcombe of Evolve Financial Planning. "When markets experience a downturn, high management costs can really eat into your returns."
Witcombe highlights Legal & General's tracker, which follows the FTSE All-Share Index. It charges around 0.5 per cent a year, without any initial set-up charges.
Tracker proponents say too many "active" funds, in which investors pay for active investment management, fail to outperform the index against which they are benchmarked – meaning investors may as well opt for the cheaper trackers.
However, any higher-risk investors seeking better returns should spurn trackers in favour of managed funds with decent track records and rated management teams.
Balanced and cautious managed funds
Like funds of funds, balanced managed funds are also something of a ready-made mix of investments. Balanced funds offer a selection of domestic and international asset classes within one fund, with the maximum equity exposure restricted to 85 per cent of the fund (compared to active managed funds, where the manager can invest the whole fund in equities).
But balanced funds are not for everyone, warns Priestley. "The level of diversification available through balanced funds helps limit the falls on your return, but it will also put a ceiling on returns, which might not suit more aggressive investors," he says.
Cautious managed funds invest in a range of assets, with the maximum equity exposure restricted to 60 per cent of the fund, and have at least 30 per cent invested in lower-risk fixed interest and cash.
Philippa Gee of Torquil Clark favours the JPM Cautious Total Return fund and also the Jupiter Income Portfolio, a fund of funds that falls under the cautious managed banner. "It's a great all-encompassing fund with a strong manager," she says.
Equity income funds
These funds have a reputation of being something like the little black dress of the investment world: investment fashions may come and go, but they never really fall out of vogue.
Equity income fund managers buy shares in companies that they believe will produce consistently high dividends. For many years, these have included the UK banks and other companies that had a difficult 2007; as a result, returns on funds popular as core holdings for years took a tumble.
However, advisers say that now might not be a bad time for prospective equity-income investors looking for long-term bets. Brian Dennehy, of the financial advisers Dennehy Weller & Co, says: "The whole equity income sector had a bad time last year, but this means now might be a good time to get in at a lower cost than in previous years."
Dennehy recommends that investors go for funds with clear strategies that they can understand. He favours Liontrust First Income, as well as Invesco Perpetual High Income, which aims to achieve a high level of income together with capital growth.
To find a financial adviser in your area, visit www.unbiased.co.uk
Global investment trusts – a cheaper alternative
For new investors or for those with relatively modest amounts to put away, global investment trusts can be among the most cost-effective ways to build exposure to global equities into their portfolio.
Global investment trusts are companies whose shares are quoted on the stock market with the sole purpose of investing in portfolios of shares in other companies. Investors' money is pooled and then invested in a range of stocks and shares across the globe to spread the risk.
Annual management charges are typically low, at as little as 0.25 per cent a year. Among the big names offering global investment trusts are F&C, Witan and Alliance Trust.
As with unit trusts, investors can buy their investment-trust holdings within the tax-free wrapper of an ISA. Those people investing via this route are free to either make lump-sum purchases or to buy into the trust in amounts as little as £25 a month.
However, not all financial advisers are convinced of the merits of investment trusts. Philippa Gee of Torquil Clark says: "They are lower cost, but the extra risks involved in investment trusts brought about by gearing – where investment trusts borrow in order to make investments – mean we don't tend to recommend them, especially when there are so many equivalent mutual and unit trusts available."
As alternatives, she suggests checking out the Artemis Global Growth Fund or Jupiter Global Managed.
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