topfunds guide 17th edition january 2010, dennehy weller
TRANSCRIPT
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This guide is produced by Dennehy Weller & Co, who are authorised & regulated by the Financial Services Authority.
Copyright January 2010 Dennehy Weller & Co. No part may be reproduced without permission
50 per copy 17th edition - January 2010
What you tell us:
quite simply the very best
extraordinarily good
rational and informativevery professionally put together
exceptional and refreshing
superb read
invaluable
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Contents
Highlights
P.11
Complacency the
greatest risk
P.12
Ageing consumers
get no credit
P.15
Unrelenting
demand for
income to drivegrowth
P.15 & 19
opportunities for
7%+ income
P.20
Thinking mans
way into emergingmkts
page
1 Whats new in this edition? 5
2 Where do you start? 6
3 What degree of risk are you comfortable with? 73.1 Questions about your attitude to risk
3.2 Inform yourself about investment risk
3.3 Understand the risk attaching to funds3.4 Current outlook
4 In Focus 154.1 A decade of growth and income - and much more to come
4.2 Evolving opportunities - corporate bonds
4.3 Emerging markets - global investors still underweight
4.4 Absolutely different - consistently protable?
5 Do it yourself? 24
6 Model portfolio - transform your mish-mash of funds 29
7 Our review and monitoring service 34
Appendices
Appendix 1 How we identify the TopFunds 35
Appendix 2 Full results of our back-testing 38
Appendix 3 About Chartwise 45
Appendix 4 Monthly risk 45Appendix 5 About Cofunds 46
Regulatory and legal information 47
Contact information 47
See additional articles and tools
on-line at www.topfundsguide.com
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1. Whats new in this edition
However you hold your portfolio of funds (within ISAs, SIPPs, orotherwise), this Guide identies and monitors funds that we believe canoutperform the indices. Secondly it gives investors a big helping hand inunderstanding and visualising risk, both the risks they are prepared toaccept and the risks within the funds themselves.
Last but not least it is linked to a FREEpersonalised review andmonitoring service (see section 7)
Welcome to this 17th edition of our 6 monthly guide
and thank you for your continuing feedback.
2010 is a year of transition, as the US and UK think
about how to withdraw stimulus, and all of us are
guaranteed pain as taxes must go up, and government
spending must go down. And China must act to take
the steam out of its boiling economy, which is bound
to create turbulence.
The scope for policy error at this delicate stage is
huge, the markets know that, so we should expect a
twitchy 2010, at best.
The possible outcomes for economies and markets
are very wide, though this potential (for better or
worse) might not be realised until 2011.
So vigilance remains a key theme. Be fully invested
by all means but stay on your toes. Our monthly
e-bulletins will help you in this regard (contact us to
be put on the distribution list).
We continue to focus on asset classes with sustainable
income ows, or where long term trends remain
powerful. And on page 21 we also consider funds
which do things a touch differently.
For those that have over-large sums on deposit there
is still a range of opportunities in corporate bonds.
Just in case, we have our unique stop-loss service.
Remember, the risks and opportunities of this
decade will be quite different to the last decade, so
we all need to keep reviewing our thinking.
Section 2: Choosing funds to suit you.Match our favoured funds to your objectives.
Section 3: Risk and your funds. Too little is done to explain risks. We help you visualise risks.
Section 4: In Focus. Massive long term potential driven by demographic change; gilt risks being exploited;
buy high yield; global investors still underweight emerging markets; absolutely different funds;
Section 5: Do it yourself. If you would rather make your own selection
Section 6: Model portfolio. Help assessing existing holdings and building a new portfolio.
Section 7: Our service. Reporting and monitoring of your funds, at no cost to you.
Appendix 1:How we identify the TopFunds. For those of you who wish to look under the bonnet of ouranalysis. Detail on the analysis process, and performance summary.
Appendix 2:Back-testing our analysis.
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2. Where do you start?
4-part process
There is much to be done before you begin to choose
funds, the whole process being in four parts:
1. suitability, particularly allowing for your
attitude to risk
2. asset allocation across your portfolio
(balancing differing sectors and fund types)
3. fund selection
4. ongoing reviews - staying in the best possible
funds
Staying in the best possible funds- OUR FREE SERVICE
Starting with the last part of the process, staying in the
best possible funds requires an ongoing service - see
more in section 7 about our service, with considerable
immediate and ongoing benets. For example, afree
review of existing funds, plus continuing monitoring
and alerts. So unless your existing adviser (if you
have one) can match our service, there is nothing to
lose by getting in touch with us now, and much to
gain.
Identifying the best possible funds
Fund selection, and how you do this, both initially
and as part of an ongoing service, is a key objective
behind this guide, and the analysis is a two part
process (see appendix 1).
Firstly we apply our statistical analysis (the objective
test) to build a short list within a sector. Secondly we
apply our subjective test, taking into account other
matters based on years of experience, to narrow this
down to the very best of the TopFunds - these are
our do-it-yourself funds in section 5, and the Model
Portfolio in section 6.
You can use the funds we identify to help you
achieve better than average performance in a
number of ways:
Building a portfolio
Constructing a SIPP/pension portfolio
Buying your ISA for this tax year
Transferring an existing ISA that isnt
good enough
Using our selected funds as a
benchmark to test your existing
holdings
The wide range of our recommended funds are
all available under the administrative umbrella of
Cofunds, whether for new ISAs or transers, or fund
purchases outside ISAs, or for building a portfolio
within your pension fund or SIPP - this Cofunds
facility offers signicant advantages at no extra cost
to you, as youll see in appendix 5.
However you normally buy your funds, and within
whatever wrapper, you should be able to use this
guide to help you invest into, and stay in, the best
possible funds.
But now we must return to the start of theprocess - suitability and risk.
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3. What degree of risk are you comfortable with?
The decision as to whether an investment is
suitable for you must take into account all of your
circumstances and objectives. In particular, the
timescale for investment, whether the objective is
income or growth, and your age. The most difcult is
matching the investment to your attitude to risk, and
that is what we focus on here.
Far too many investors jump straight into buying
investments without considering if risk investments
are right for them.
One commentator said Human beings are not cut out
to be natural investors, and this is an uncomfortable
truth for many of us. Millions of years of evolution
have given us a brain that can instantly process
visual images, assess threats, develop language and
(sometimes?) make informed choices given sufcient
information.
But those millions of years of evolution have not
enabled the development of the ability to invest
rationally. Some say this is because nancial
markets are a relatively new hunting ground, and
given another few hundred thousand years we
may get better at it. Others tell us it is to do withour unconscious impulse to herd (i.e. if everyone
else is buying we want to play too), and once in a
crowd an ordinarily rational person has a tendency
to irrationality (which is why we get investment
bubbles).
Whatever the reason, because of our inherent inability
to invest rationally, it is vital that we construct (in one
of our rational moments) a sound framework within
which we deal with risk investments from year to
year. For most investors that means having a process
to guide you through building a portfolio, and, for the
future, the support of a review service like ours - so
when the rest of the investment world is losing its
head, you dont lose yours and a large chunk of your
investment capital.
Before considering risk in more detail, it is important
to remind ourselves that the stockmarket does offer
the opportunity for superb long term rewards the
sharp falls in 2008 are notrepresentative of the long
term - see more in section 3.2. Even so you must
understand that these rewards are available because
you take on risk - risk and reward go hand in hand.
What degree of risk are youcomfortable with?
There is no perfect way to assess this. Asking this
question of yourself in a void (without also having
some understanding of investment risk and history)
is of limited or no value. A sensible way to proceed
would be:
3.1 ask yourself questions about your attitude to
risk
3.2 inform yourself about investment risk
3.3 understand investment risk attaching to funds
And at the end re-check your answers to 3.1, as you
may feel more or less happy about risk having gone
through the whole process.
Human beings are not cut
out to be natural investors
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3.1 Ask yourself questions about your attitude to risk
Imagine you invested 10,000 just 6 months ago.
There is some unexpected news, and the stockmarket,
and the value of your fund falls to 7,000, down 30%.
How would you feel?
would it cause you grave concern and worry?
Or
would you be relatively relaxed, because you
are comfortable continuing to take at least a 5
year view?
Even if you are relatively well off, with secure
income, such falls may still give you sleepless nights
how you might react is a very personal matter.
My funds have fallen 30%!! If this would be a
shock you would rather not experience, sell or reduceyour risk investments. It might mean you miss out
on a continuing recovery or that you dont suffer
further sharp losses, but that isnt the point. Whether
you should remain invested is about you and your
attitudes, not about markets. You need to make a
hard-nosed decision about whether you can cope with
risk investments, and crystallising losses should be
regarded as the price of experience.
The stockmarkets can and do play games with your
mind, in particular with the powerful emotions of fear
and greed. Some investors may just need assistance
to think a little more rationally.
For example, do you have secure income, more
than enough on deposit for peace of mind, and no
debts? Just re-afrming this will help many stop
worrying. But if, despite this high level of personal
nancial security, you still cant sleep at night with
the possibility of your investments falling sharply,
you should sell, whatever you might think about the
stockmarket and its potential.
This is a very basic approach to guring the level
of risk with which you are comfortable, and there
are more formal approaches for testing your risk
tolerance, which would ask questions such as:
do you think of risk as uncertainty or
opportunity?
are you more concerned about possible gains
than possible losses?
when things have gone wrong nancially in the
past have you adapted easily or uneasily? have
you looked for someone to blame?
If you would like to go through a more formal risk
tolerance test, do get in touch, and we will let you
know the details and cost.
3.2 Inform yourself about investment riskOur view on risk is black and white, and it comes to
this: if you read section 3 and at the end still dont feel
that you have a sense of what investment risk is, then
you should not touch risk investments. There is no
shame in this, they simply arent right for everyone.
Past performance is not a guide to future performance.But history is a good place to start to explore how
well different asset classes have performed over long
periods, and what can go wrong. You can see in
the table at the top of the next page how, providing
you take a sufciently long view, the probability of
equities or shares providing better returns than bonds
or leaving the money on deposit is very high. These
gures are based on analysis of the stockmarket from1899 by Barclays Capital.
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Probability of shares beating bonds or deposits
consecutive years of investment
2 5 10
Deposits:
probability of equity outperformance 67% 75% 93%
Bonds:
probability of equity outperformance 70% 76% 82%
Over longer periods a key issue is whether the returns
from any of these asset classes also beat ination.
The CSFB Equity-Gilt Study considered every 10
year rolling period since 1879. Equities did better
than ination 87% of the time, gilts 60%, and cash
65%.
So the case for investing in the stockmarket is clearlycompelling.
But you must also understand howthings can go wrong
Contrary to the perception of many that were new to
investment in the decade up to 2000, stockmarkets
go down as well as up; the bear market of 2000/2003
being a rude re-awakening, reinforced in the Autumn
of 2008. From 1918 to 1977 you would commonly
have seen one year in three with the stockmarket
declining, falls of 20-30% being commonplace. Thebear market from 2000-2003 was the rst reminder
for some time that volatility in most of the last
century, prior to 1977, was the norm. But through all
of these ups and downs the long term trend remained
up, you just needed patience.
The average downturn (bear market) in the US
stockmarket since 1875 has produced a fall of 32%
from peak to trough, and lasted 18 months. Patience
got you through the average downturn.
Looking at the above table, (equities outperform
deposit returns 93% of the time over 10 year periods),
you could feel quite unlucky having lived over the last
10 years. Yet it has not been as bad as some analysis
would have you believe.
For example, over the last 10 years the FTSE All
Share Index is down 14.8%, compared to a 90 day
deposit return of 37% (according to Moneyfacts). Butthis is distorted. If dividends were re-invested the
index was up 17.7%. If you consider a reasonable
equity income fund (the most popular stock market-
linked funds) they have done even better. Newton
Higher Income is ahead by 81%, and Invesco
Perpetual Income was up 141%.
You could be this unlucky - theaccidents of history
You can easily factor into your thinking occasional
years of weakness such as just described, as these can
be dealt with by patience and a sensible timeframe
for investment. But very occasionally, perhaps once
every few decades, it can get somewhat worse.
In real terms (that is after allowing for ination)
the US stockmarket peak of 1929 was not regained
until 1954 (25 years), and the peak of 1966 was not
exceeded in real terms until 1995 (29 years).
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We call these accidents of history (what Nassim
Taleb has more recently called black swans). If you
had invested in 1970 could you really have envisaged
that oil prices would quadruple in the years just after?
No. Nor could some of our parents and grandparents
have guessed that their lives would be consumed by
two World Wars and a depression. Sometimes fate is
just going to deal you a tough hand.
Put together with what occurred in markets in 2008,
this is all quite scary. But context is required. For
example, after the 1929 peak the trough for the US
stock market was in 1932, a bear market of just 3
years. Now consider that following the falls in UK
and US stock markets in 2008, it can be argued that
we have been in a bear market for 9 years already.
That being the case, are we more likely to be in the
middle or nearer the end of this downturn? Fingers
crossed it is the latter, and 2010 is a year of transition
- the dawn of 2011 should add clarity.
the rewards - theyre very signicant
To provide balance, it must also be made clear that
stockmarket investment has provided superb returns
over long periods. For example, 100 invested in
the stockmarket in 1945 has grown to 92,460, with
dividends reinvested (Source:Barclays Capital,
2008). If you had alternatively invested into gilts or
left your money on deposit the comparative values
would be just 4,550 or 5,789 respectively.
3.3 Understand investment risk attaching to fundsNow we consider different types of funds, and
their investment risks, in the context of three broad
categories of risk. The focus is our experience with
these funds over the last 10 years - you should also
consider the longer historical picture in section 3.2.
Please remember that past performance is not a
guide to future performance. But history is useful in
enabling you to explore what sorts of investments suit
your circumstances and objectives.
lower riskYou are prepared to accept some capital volatility
for the potential of a better return than on deposit,
but do not want the day to day risk of a stockmarket
investment. This lower risk sector would include
corporate bond funds, international bonds,
commercial property funds and also protected funds.
the reward:
Over the last 10 years, the total return from a good
mainstream corporate bond fund was 85% (netincome re-invested), whereas on deposit it was
55%. Over longer periods our expectation is simply
for a margin over deposit returns. Corporate bonds
continue to look attractive with interest rates close to
zero and so many bonds priced under par.
the risk:
Looking at a typical good lower yielding corporate
bond fund, based on the last three years, our statistical
analysis suggests that in most months you should not
see a fall in the capital value exceeding 3.2%*.
Until 2008, looking back a little beyond 10 years, the
worst period was 1994/5. A typical lower yielding
bond fund would have lost about 9% in 1994/5, and
if you had been drawing income the fall in the capital
value would have been more like 15%. In 2008
there were similar falls by many, though some lost in
excess of 20%. As a guide, the higher the yield on
the bond fund, the greater the potential downside.
medium riskFor those comfortable with stockmarket risk, meaning
that youve probably lived through periods of extreme
volatility before, and are comfortable taking a longview (at least 5 years). This would cover mainstream
UK, European, and well diversied Asian funds.
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the reward:
Over the last 10 years, the total return from a typical,
good, UK stockmarket fund (in this case an equity
income fund) was 85% (net dividends re-invested),
or 48% from a good fund in the UK All Company
sector. In contrast, the deposit return was 55%, and
the stockmarket index went up just 17%.
the risk:
Looking at a good fund in the UK All Company
sector over the last three years, the statistical
analysis suggests that in most months you should not
experience a fall in the capital exceeding 7.9%*.
Looking back over 10 years, we have still not
recovered the peaks of 1999/2000. The falls began
in early 2000 (down 43% at worst on the FTSE All-
Share) and, despite a strong recovery through to 2007,
and again in 2009, the index is still more than 30%
below the all time high.
A typical good UK stockmarket fund would have lost
a bit more than 30% in the period 2000-2003 though
many were at worst down in excess of 40%, similarly
from autumn 2008. Prior to that, the steepest loss for
our typical good fund was 14% in 1994, and took
18 months to recover.
high riskThis means that as well as your being attracted to
some years of 100% growth (such as with tech in
1999), you must also accept years of 50% losses,
sometimes more, and take a 10 year view, at least.
This includes tech, focussed Asian funds, emerging
markets, smaller companies, and commodities.
Our experience is that high risk funds often do not
provide the consistent year to year performance of
something like a good mainstream UK stockmarket
fund. Not only will you see the value 100% up and
50% down over relatively short periods, but for
long periods (years) you may experience lacklustre
performance, until it explodes upwards.
the reward:
Occasional years of 100-200% returns.
the risk:
In the higher risk area we can consider a number ofsectors to illustrate the risks. Looking at a typical
emerging markets fund, based on the last three years,
the statistical analysis suggests that in most months
you should not see a fall exceeding 15%*.
Over the last 10 years the worst period for a typical
Japanese fund was the 44% loss to August 1999. And
80%-plus losses have been experienced by tech funds.
*see appendix 4 for more on monthly risk
3.4 Markets focus: not the time to relaxWith all investment markets up sharply since
March 2009, and most economies seemingly out of
recession, the big risk right now is complacency.
There is a plausible argument that low interest rates,
and lots of cash washing around the globe, will
push markets to much higher levels, led by emerg-
ing markets and Asia. But equally plausible argu-
ments can be made for a very gloomy 2010, and with
complacency in the ascendancy we feel this space isbest utilised to highlight some current problems, and
re-establish a bit of balance.
We are still in the midst of a huge, unprecedented,
experiment, which began in the Autumn of 2008, as
vast sums were thrown at the global economy to pull
it back from the brink. Some countries could com-
fortably afford this action (e.g. China), others cannot
(e.g. the US and UK).
There are two big questions. What will happen when
1. China increases interest rates (a process which has
just begun) to cool their booming economy and limitinationary pressures 2. the US and UK withdraw
stimulus packages, because they cant afford to con-
tinue with them (particularly the UK).
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The truth is that no one knows, so we need to iden-
tify investments that might be particularly vulnerable
(perhaps through over-valuation), and also consider
catalysts for renewed turbulence`.
valuations not stretchedAll asset classes have recovered sharply, but only
the US looks toppy. For example, UK and European
stock markets arent bargain basement, as they
were in March 2009, but nor are they particularly
expensive.
Asia and emerging markets look reasonably priced
bearing in mind the earnings growth potential. In
contrast the US market looks overvalued on a range
of criteria, and, beyond 2010, there is uncertainty over
earnings.
government bonds are a worryCorporate bonds are not a concern (see more insection 4.2), and most businesses are in robust
nancial shape (with lower costs, less debt, and more
cash than a couple of years ago), and the peak for
defaults is past.
It is more difcult for governments bonds,
particularly for the US and UK and fringe European
states. This is important:
rising government bond yields could be the
catalyst for renewed instability, both in markets
and the wider economy
The yields on government bonds reect a range of
issues for example, the outlook for ination, and the
ability of a government to meet interest payments and
retain a manageable level of debt. As the UK came
out of prior recessions if gilt yields went up it was
because the economy was recovering, and ination
expectations were raised a bit - stock markets tend
to do well in this environment as prots are rising.However, this time a new concern is the volume of
government bonds that need to be issued, who will
buy them, and at what price.
The UK government has sharply increased its debt
levels to pull the economy back from the brink, and
this is set to keep rising, with heavy gilt issuance for
a number of years to come. To manage rising debt
levels the government requires a healthy income
(from taxes) and lower costs.
But this is easier said than done. The tax take
is limited when economic growth is limited, and
this is made worse because the tax-paying working
population is shrinking as the baby boomers (the
bulge in the population born from 1945) are now
rushing towards retirement.
The easy availability of credit has been key to the
economic recovery out of prior recessions. By
the second half of the 1980s the UK economy wasbooming, yet unemployment was stubbornly stuck
at 10%. In so far as consumers were (and remain)
responsible for the bulk of economic growth, the
condence of those in work was vital, and their
willingness to take on debt, which meant that they
could buy stuff more quickly than if they had to save,
brought forward the recovery. But consumers are
now wary of debt.
ageing consumersConsumers now appear to be in the middle ground.
Shopping centres are still packed on Saturday
lunchtimes, and it is also difcult to nd a parking
space late in the afternoon a basic test of consumer
condence, but one we can all observe. For those
in work there is still surplus income to be spent, as
we should expect in a low interest rate, low ination
world. What is not happening is a rush to take on
more debt in fact it appears that debt is being repaid
and savings are increasing, very healthy in the long
run, but limiting economic recovery in the next yearor two.
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As the average age of the population increases, and
the retired proportion grows, the natural caution of
older people will also limit willingness to take on
debt, and this feature will be in place for a number of
decades to come.
For example, by 2040 in the UK there will be 40
people aged over 65 for every 100 people aged 15-
65, a 60% increase on this ratio (the dependency
ratio) today. See the end of section 4.1 for a graphic
illustration of this global phenonemon.
As renowned economist George Magnus has
calculated, the cost of cleaning up the banking
crisis will be up to 25 per cent of GDP, but the
cost of supporting the UKs ageing population will
be considerably higher. The next four decades of
pensions, healthcare, disability benets and residential
care will cost 330% of GDP (700% in the US!).
All of that is a long way of saying that the UK
governments ability to increase its tax take and
reduce its costs will not be easy (similarly in the
US). Look out for these stresses being reected in
rising gilt yields, triggering increased risk of the
stock market being destabilised (even though it is not
obviously over-valued).
risk of economic relapse?If economies begin to slow down again (the W shaped
recession) this will also hit the governments tax take.
It is the US where this can best be observed. Yes,
there has been a statistical economic recovery,
but nearly all of this can be accounted for by
government stimulus packages. The concern is that
later in 2010 and into 2011, as stimulus is withdrawn,
it will become much clearer that the recovery is
not sustainable. Ordinarily a slowing economy
implies lower ination and lower government bond
yields. But if the people that might buy your bonds
(the Chinese?) are concerned about your economic
stability, if not the risk of default, government bond
yields must go higher to entice buyers.
Many of these concerns are common to the UK and
the US. Then add into the mix the possibility of one
smaller nation defaulting on its bonds, increasing the
perceived risk of default by a larger countries (even if
unrealistic), and there is a recipe for instability.
We could go on with a litany of negative possibilities,
and we could really scare you with some numbers
produced by a very vociferous, and angry, group
of US analysts who are permanently of the Private
Frazer tendency were all doomed.
The point of all this is simply to highlight that as
you ght for the last parking space in your local
shopping centre late on a Saturday afternoon, as
you nd yourself with surplus income to spend and
save at the end of each month, as you look back at
2007 and 2008 and wonder who was the idiot who
said there was a credit crunch and now tells us
we are amidst the Great Recession, you mustnt
become complacent.
Although there are some very positive long term
trends, and other areas of good value (as we explore
throughout section 4), in the shorter term there are
still problems to be overcome.
portfolio emphasis?As we navigate through this year of transition we
will continue to focus on areas with decent value
(typically with a healthy income stream) or where
there is an obvious long term trend in your favour, or
where a fund manager has displayed a certain skill
in generating decent returns while limiting downside
risks. Dont hesitate to drip new money into your
chosen funds - let us know and we will help you with
this.
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4. In focus
Some headlines over the holiday period would have you believe the last decade had been awful for
investors. It wasnt. Yes it was tough, but...
So instead of another list of 10 or 20 things to worry about in 2010 (see last section!), in the table below we
show how some of the most popular funds in the equity income sector have performed over the last decade, and
then underline the very positive outlook.
4.1 A decade of growth and income - and much more to come
Equity Income Funds - 10 Year Performance
Fund name Total return % Fund Size Million
Schroder Income 97.53 1,335
Rathbone Income 90.21 520
Newton Higher Income 81.34 2,847
Jupiter Income 69.02 2,878
BlackRock UK Income 67.71 356
Liontrust First Income 61.33 368
Standard Life Inv UK Equity High Income 58.96 837
F&C Stewardship Income 51.68 264
Average UK Equity Income Fund 42.91
Moneyfacts 90 day notice account 10k 37.75
FTSE All Share 17.71
Average UK Growth fund 17.01
Bottom line? The equity
income funds that investors
have been buying in scale
have been just ne.
As you can see in the
table, these bigger funds,
some huge, have rewarded
investors, not just in absolute
terms, but also compared toother alternatives.
For example, the growth-
focussed funds in the UK All
Company sector on average
performed worse than the
stock market as a whole.
why did big funds outperform?A key reason for these bigger equity income funds also outperforming their own sector average is because they
tend to have a greater weighting in the larger, safer, UK-quoted businesses with a global franchise.
Interestingly, many such businesses were overlooked in the stock market rally of 2009, but we believe that trend
has already begun to reverse. This is reected in the Newton Higher Income fund (with a heavy focus on multi-
national heavyweights) being 4th quartile over 1 year, but a much more positive 1st quartile over more recent
periods.
positive outlookOn many occasions we have highlighted the attractions of buying higher yielding shares through equity income
funds. And this overview of the last decade could not be clearer in highlighting their successes, and the key role
of reinvested dividends in driving performance. Looking forward the outlook remains very positive, both
short and longer term.
Looking at the short term, not only did theNewton Higher Income increase the payout by nearly 20% in 2009,
but the manager Tineke Frikee is expecting a little more income growth in 2010, even though the yield is already
a chunky 7% gross.
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No sooner wasJOHCM UK Equity Income
projecting an increase of 5-7% in their payout
for 2010 when four of their holdings announced
dividends even higher than expectations, very
encouraging.
TheJOHCMfund was in top place for total return
(growth plus reinvested dividends) in 2009, followed
byBlackRock UK Income, and Schroder Income
these three funds up are 40.36%, 37.96% and 35.87%respectively (the sector average was just 23%), and all
remain optimistic. The gross yields are 4.41%, 3.6%,
and 4.2% respectively.
massive longer term potentialThere is a risk as we focus on the short term that we
miss the powerful long term, secular, changes driven
by unfolding demographics.
The chart below shows the growing dependency
ratio in a number of key countries the ratio is thenumber of retirees per 100 people aged 15-65. This
is not a parochial UK tendency, but a global one
(India probably being the main exception, due to its
remarkably young population).
Now think of this chart another way - it vividly
illustrates the inexorable rising demand for
income. The search for reliable income will be all
the greater in countries like the UK, as nal salary
pension schemes close, and the Government reduces
State benets for the retired (by hook or by crook!).
In the years and decades to come high yielding shares,
those with reliable dividend ows, will increasingly
attract premium values, and the equity incomefunds that invest into them should be at the heart of
portfolios (even for investors with a growth objective,
to capture the powerful impetus provided by the
reinvestment of dividends).
And while capital values might go up and down,
remember dividend payouts are always positive.
spread your net wideIf you are a bit nervous about the UK economy you
should remind yourself that the UK stock market
is not representative of the UK domestic economy.
Only about 30% of the earnings of FTSE 100
companies are generated in the UK.
Nonetheless to buy funds solely focussed on the
UK stock market is to miss out on a wide range of
opportunities - 90% of the worlds high yielding shares
are outside the UK. Consider these favourites:
Sarasin International Equity Income (yield 4.9%)
unashamedly focuses on quality businesses with
limited debt, and the commitment and ability to grow
the payout, and in 2009 the payout increased by 15%.
During a year of transition, with the global economy
slowly coming off life support, this fund is attractive.
Newton Asian Income fund surprised on the upside
again. The manager was cautious earlier in 2009, but
the payout over the calendar year is up 5% compared
to 2008, and there should be a further increase in
2010. Similarly withIgnis Argonaut European
Income, payout up 3.62% in 2009. The respective
yields are 4.6% and 5.6%.1990 2000 10 20 30 40
Figures from 2010 are forecastsSource: IMF: UN
Dependency ratio by country
47
35
25
JAPAN
CHINA
SPAIN
UK
US
INDIA
52
65
52
38
26
2420
30
47
47
40
35
30
252424
17
31
24
191919
33
36
24
17
12
108
16
13
1088
7
Number of 65+ dependantser 100 persons aged 15-64
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What a year for corporate bonds! Remarkable gains, in some cases in excess of 50% from the March lows.
Yet opportunities persist, and here we review the journey so far, and consider what might lie ahead.
Looking at calendar year 2009 simply doesnt give us a sense of the excitement of the last 12 months in
corporate bonds, a sector which in years past had the primary characteristic of being dull. In the table below we
have shown the considerable ups and downs of selected bond funds which straddle all three sectors and a variety
of approaches.
The table shows two time segments, rst meltdown (1st September 2008 to 24th March 2009) and then
recovery (25th March 2009 to 31st December 2009).
Total Return Bid-Bid performance from UK Retail UT and OEICs universe.Rebased in Pounds Sterling
Name25 Mar 09 - 31 Dec 09 01 Sep 08 - 24 Mar 09
Performance Rank Rank Performance
Henderson New Star Sterling Bond 57.71 1 17 -39.43Old Mutual Corporate Bond 56.13 2 16 -35.01
F&C Extra Income Bond 51.71 3 15 -32.49
Henderson New Star Fixed Interest 49.79 4 14 -32.03
Schroder Monthly High Income 46.31 5 7 -13.29
M&G High Yield Corporate Bond 43.01 6 11 -19.92
Henderson Strategic Bond 42.73 7 10 -19.42
Artemis Strategic Bond 41.84 8 12 -24.58
UT UK All Companies Retail 40.88 9 13 -29.46
Investec Monthly High Income 39.2 10 9 -18.96
Invesco Perpetual Corporate Bond 29.06 11 5 -11.33
UT Sterling Corporate Bond Retail 23.02 12 6 -13.24
Investec Sterling Bond 21.29 13 3 -6.21
Fidelity Money Builder Income 20.75 14 4 -7.2
Standard Life Investments Corporate Bond 19.62 15 8 -14.03
M&G Corporate Bond 18.2 16 1 -0.13
Jupiter Corporate Bond 15.24 17 2 -4.91
4.2 Corporate bonds - evolving opportunities
We have ranked the funds (and benchmarks) and you can clearly see how the outliers (top and bottom) sharplyreversed between the two periods. Regular readers know that this reversal was all about bank bonds, sharply
swinging from the role of villain to hero.
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The positive trend driven by banks and nancials
since the March 2009 turning point is likely not yet
over, even after rises in excess of 50% for some
funds. Clearly you mustnt expect such heady gains
in 2010; with banks and nancials driving perfomance
again, total returns around 10% are a fair target, and
still some way in excess of cash deposits. These
funds are ideal for ISAs.
Below is a table breaking down bank bond and
other nancial holdings for key investment grade
corporate bond funds. Regular readers will know that
the greatest risk lies with the tier 1 bonds, and least
with senior. So the greatest risk, and potential,
is generated by theHenderson New Star Sterling
Bond. Not surprisingly this Henderson New Star
fund and that from Old Mutual were two outstanding
performers from March 2009, as you saw in the
previous table.
gilts problemHowever, from section 3.4 you know that we are
concerned about gilt yields - and higher gilt yields
will be unhelpful for both the stock market and
corporate bonds. Over the last 10 years 80% of the
return from investment grade corporate bonds can
be explained by the return on gilts what this means
is that, to a signicant extent, where gilts go, the
investment grade corporate bond market will follow.
Yet this is not necessarily bad news forfunds whichinvest in corporate bonds. Corporate bond funds
can use derivatives to limit their sensitivity to gilts,
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and if they are strategic bond funds they also have a
much wider range of assets from which to choose, to
limit that sensitivity.
TheHenderson Strategic Bondfund is one fund
exploiting this uncertainty. Not only was it up
noticeably in the nal months of 2009, as many
peers drifted sideways, but it achieved this by steady
progress, with very little volatility. A key contributor
was the use of derivatives, to reduce the exposure to
gilts among other things. A fund for 2010.
buy high yieldOne of the most consistently top quartile high yield
funds isSchroder Monthly High Income (gross
yield 8%). The reason why high yield is attractive
is because, as Schroder manager Adam Cordery puts
it, the correlation with interest rates is so low that
rising government bond yields probably arent much
to worry about.
Of course there are other risks - they are higher yield
because there is more risk than with investment
grade bonds. But it is a renewed serious economic
downturn, or shock similar to Autumn 2008,
which would be required for serious damage to be
encountered. Excepting that possibility the key is
experienced fund managers. As well as the Schroder
fund theHenderson New Star High Yield Bondand
Aegon High Yield Bondstand out. Again returns
around 10% are a decent target; you also benet from
being less exposed to trends that might negatively
impact on higher quality investment grade bonds.
FundAverage
Price
TOTALBanks &
Financials
Bank Bonds BreakdownOther
nancialsSeniorLowerTier 2
UpperTier 2
Tier 1
Old Mutual Corp Bond 88.2p 42.40% 2.60% 15.20% 2.40% 5.50% 16.60%
Henderson New Star Sterling Bond 95.8p 50.40% 3.75% 13.80% 5.90% 13.80% 13.20%
Inv. Perp. Corp. Bond 97.8p 50.00% 9.20% 6.00% 1.30% 12.00% 21.50%
Stand. Life Corp. Bond 98.6p 39.60% 17.50% 14.70% 2.50% 4.20% 0.70%
M&G Corp. Bond 99.98p 30.90% 7.00% 11.00% 0.50% 2.20% 3.60%
Fidelity Moneyb. Inc 101p 22.10% 6.80% 8.40% 1.50% 1.80% 3.60%
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4.3 Emerging Markets - global investors still underweight
Never have we known such divergent views on
nearly every asset class, and emerging markets are no
exception. They are either good value and expected
to explode upwards, or are already hugely over-valued
and about to fall sharply, with China in the vanguard.
So how should you respond?
Identify the most compelling long term trends and
nd the most painless way to gain an exposure.
Huge they might be, but China, India, and Brazil are
still emerging. This can be illustrated in a range of
ways, focussing here on China:
- Electricity use per head in the US is 13,582Kwh. It
is 6,185Kwh in the UK and 8,220Kwh in Japan. But
in China it is just 2,041Kwh.
- By 2035 the Chinese economy might be 17 times as
big as it was in 2004 (according to Goldman Sachs)
This economic transition will not be without
turbulence, but there is a marked determination on
the part of the Chinese Government, evidenced over
years, and most recently with their huge and rapid
response to the sharp slowdown in Autumn 2008.
Shorter term factors can also drive their stock markets
somewhat higher. Many analysts expect global
interest rates to stay lower for longer, as central
bankers and politicians fear making the mistake of the
1930s, increasing rates too soon. That being the case
there will remain a lot of cash washing around the
globe looking for a home.
We believe a disproportionate amount of this
money will nd its way to emerging markets. With
the developing world now responsible for just over
half of global GDP, the vast majority of institutions
www.topfundsguide.com
and global funds will nd themselves having far too
little in emerging markets on a GDP-weighted basis.
Its not all about China. Regular readers know that
our favourite country is India, followed by Brazil.
And emerging markets as a whole came of age in
2008 and 2009. As Barclays Capital put it:
the ability of EM to weather the most severe
nancial crisis in seventy years dramatically
changes the nature of the asset class
dips, drips and BasicsLonger term investors will ideally want to buy on dips
(the markets arent cheap now) or drip in each month,
and let the volatility work for you as you average out
your buying price over time.
TheAxa Framlington Emerging Markets fund
continues to be recommended, along with the Mark
Mobius team running Franklin Templeton Global
Emerging Markets.
Another way to access the positive trends in emerging
markets is throughM&G Global Basics, an old
favourite that we christened the thinking mans
way into emerging markets. In essence it invests
in companies that produce the goods or services
needed by China and other emerging markets. The
skill of the manager Graham French is in identifying
shifting trends in business or consumer trends, and
uncovering companies that will exploit this evolution,
which he calls the curve of economic development,
with commodities at one end, and luxury goods at the
other. This fund represents a conservative, but still
very protable, way into emerging markets.
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In an increasingly complex world, where both risks
and opportunities are not always obvious to the
untrained eye, funds that employ a richer mix of
strategies, wherever they might arise, are attracting
growing interest. All the more so when they also
apply this strategy with somewhat less risk, and lower
volatility, than mainstream equity funds.
Here we look at three such funds that complement
each other.
Newton Real Return- the grandaddy
This Newton fund has a long history, back to 1989.
Over the last 10 years the fund has grown 44%,
impressive for a relatively low risk fund, sharply
outperforming both the stock market and deposit
returns.
In some respects the fund takes a traditional approach,
having a large exposure to equities (around 50%),
and buys taking a long view in the style of the likes
ofM&G Recovery orFidelity Special Situations.
Where it is different is that it takes somewhat less
risk (about half the level of the stock market) by
having higher allocations to cash in times of raised
uncertainty, or use put options for insurance, or by
buying other assets, such as bonds.
As with each of these three funds, there is no
guarantee and when the markets fall sharply this fund
will not be immune. For example, it fell about 15%
in the Autumn of 2008. But this compares favourably
with the UK stock market, which fell 45%. Better
still, the manager reacted rapidly to events, making
up all the lost ground and more by January 2009,
whereas the broader stock market carried on falling
for a number of months.
TheStandard Life Investments Global AbsoluteReturn Strategies fund enjoyed a very similar
experience in Autumn 2008 - if the value falls over a
short period it need not be unduly worrying where the
managers of the fund have the skills and exible brief
which allows them to adjust rapidly in the wake of
unfolding events. This feature is vital.
Standard Global Absolute Return -huge range of strategiesThis Standard Life fund has much less emphasison equities and more on a wide range of strategies,
wherever they might arise around the world.
Spreading the net in this way (as we write 27
individual strategies are being pursued) is key to
spreading risk, and limiting downside, as evidenced in
Autumn 2008.
This fund went up 18% in 2009, taking less than half
the risk of a typical stock market-focussed fund.
Artemis Strategic Assets- off to a ying start
This is the youngest of these three funds that do
things just a bit differently from so many of their
peers. It has a similar approach to the Newton fund,
but is a little more aggressive than these two peers, up
a chunky 18% since launch in May 2009.
For example, the fund had 45% in cash in June, but
only 20% by the end of 2009.
The manager, William Littlewood, was previously
best known for his highly succesful tenure managing
theJupiter Income fund, and his reputation and the
early success of the fund has allowed the fund to
quickly grow to in excess of 300m.
how they t in your portfolioThese funds are part of the low risk mix in your
portfolio, being somewhat less volatile than pure
stock market funds. As such they can account fora large proportion of your portfolio, and we would
typically recommend a selection of these funds, to
take advantge of the range of strategies.
4.4 Absolutely different - consistently protable?
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For those that dont require tailored advice the
DIY approach is vastly more practicable due to the
innovation of fund supermarkets, such as Cofunds
or FundsNetwork. They offer a huge choice, about
1200 funds, and considerable administrative benets
without extra cost (see appendix 5 for more detail)
making DIY with your portfolio of funds very easy
(whether ISAs, your pension fund, particularly if a
SIPP, or otherwise).
In addition to the funds below there are undoubtedly
other worthy funds that you could comfortably
consider, as included within the Appendix 2 tables.
But many more are not worthy of consideration, and
shouldnt be purchased, or, if you hold them already
should be sold and the money re-invested into better
funds. See section 7 regarding a review of your
existing funds. We would advise you not to become
too xated on historical growth (or losses!) alone,
and do carefully consider the degree of risk withwhich you are comfortable, as set out in section 3,
and the funds monthly risk gure (see appendix 4 on
monthly risk).
For clarity, do bear in mind that these selections
assume that you are going to build your portfolio
now, from scratch, which means the fund selections
can change quite dramatically from one edition
to the next. For those that have existing portfolios,
and to help put changes over the last 6 months in
perspective, we identify any changes in the text below.
The funds are split between those invested primarily
in the UK, and those invested primarily overseas.
UK SHORT LIST
Lower riskA superb 6 months with 6 out of 9 funds up by 20% or
more, and all in positive territory.
Taking more risk in corporate bonds (adding the
5. Do it yourself? ...Want to make your own choices?
Henderson New Star Sterling Bondand Old Mutual
Corporate Bondfunds) worked very well, with the
former fund up in excess of 25% in the last 6 months
of the year.
As explained in section 4.2, we believe that the
bank bonds that feature in these two funds (and the
strategic bond funds) can again drive performance in
2010, though perhaps low double digits gains for the
whole year rather than a repeat of the excitement in2009. TheM&GandStandard Life funds continue
to provide a stable base, and the two strategic bond
funds (from Artemis and Henderson) can roam the
bond spectrum seeking out opportunities.
In addition there are continuing opportunities in
high yielders, which should not suffer (much?) if gilt
yields go somewhat higher. So we will replace the
(excellent) Old Mutual Corporate Bondfund with
Schroder Monthly High Income, which will provide
a bit of diversication. The F&C Extra Income bondhas lost its rating, but is still delivering, and not far off
those funds that are rated - hang on.
TheBlackRock UK Absolute Alpha fund
disappointed in a rising market (up only 1.7% over
the 6 months, a touch behind theJPM Cautious
Managedfund which it replaced). Most long holders
of the fund will not baulk at this as over most of its
life it has been a bit of a star - it went up in 2008
when the stock market as a whole was down 30! One
or two positions spoilt performance over the last 6months, and we are content to hang on.
Standard Life Select Property is the sole property
fund featured, and was up 22% over the period. But
the fund is still down about 50% from its peak way
back in 2007, which highlights how bad it got for
the property sector, in the UK and globally. This
is an unusual fund as it is a mix of global property
securities (about 70%) with the balance in global
bricks and mortar. With property securities still fair
value, and bricks and mortar beginning to recover,this is an interesting blend of a fund for those looking
to steadily rebuild their property exposure.
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DIY UK FUNDS
Co and fundGrowth last6 months
Sector Rating Risk Objective
grth inc
LOWER RISK
1 M&G Corporate Bond 10.6% Corporate Bond Silver 3.2 y y
2 Standard Life Inv Corporate Bond 9.0% Corporate Bond Bronze 4.0 y y
3 Henderson New Star Sterling Bond 25.4% Corporate Bond Bronze 9.1 y y4 Artemis Strategic Bond 19.4% Strategic Bond Bronze 6.7 y y
5 Henderson Strategic Bond 22.2% Strategic Bond Bronze 6.1 y y
6 Schroders Monthly High Income 23.1% High Yield Bronze 7.2 y y
7 F&C Extra Income Bond 22.4% Strategic Bond None 7.6 y y
8 Black Rock UK Absolute Alpha 1.7% Absol. Return Silver 2.4 y
9 Standard Life Select Property 22.3% Property Silver 10.0 y y
MEDIUM RISK
10 Newton Higher Income 21.4% UK Equ Inc Bronze 7.9 y y
11 Artemis Income 22.6% UK Equ Inc Bronze 8.5 y y12 Jupiter Income 18.6% UK Equ Inc None 8.9 y y
13 St. Life UK Equity High Income 25.6% UK Equ Inc Bronze 9.4 y y
14 JOHCM UK Equity Income 31.0% UK Equ Inc Silver 11.2 y y
15 M&G Recovery 27.9% UK All Gold 10.3 y
16 Newton UK Opportunities 21.2% UK All Silver 7.6 y
17 Artemis UK Special Sits 14.9% UK All Bronze 8.9 y
18 M&G Smaller Companies 26.0% UK Smaller Bronze 13.0 y
Medium riskThis is split between the equity income funds and growth funds, including smaller companies. Of the nine
funds, 7 returned in excess of 20% for the 6 months. The star turn isM&G Recovery (again) up 28%. We are
a little concerned over smaller companies, being unsure about a domestic UK recovery - but thisM&G Smaller
Company fund has been top quartile for every period up to 5 years, and the manager is still uncovering value and
diligently selling once that the share price is re-rated. Hang on.
Other thanM&G Recovery, which has been steady throughout, it has been an interesting selection of funds to
observe, not so much over just the last 6 months of the year but rather from the turning point in March 2009.
Some roared away in the spring, others began to outperform later in the year - all in all a spread of approaches
represented by these funds.
The UK equity income funds tended to underperform the index until late in the year, and we fully expect the
positive trend of late 2009 to continue in 2010, as relatively cheap multi-nationals with safe dividends attract
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greater attention. In fact we dont believe the
recovery in equities can be regarded as sustainable
until these larger multinationals are bought in scale.
As we said last time, it is dividends which are the
most important component of long term returns, and
companies with high and sustainable dividends will
attract an increasing premium for many years to come
as demand inexorably increases from an ageing global
population (see section 4.1)
Therefore equity income funds that have a
commitment to generating above average payouts
are necessarily a focus of this selection. If we
judged all the funds on the outcome of 2009 we
would have few left! Most funds cut the payout.
Newton Higher Income was an exception, and an
outstanding one, raising the payout by 20% in 2009.
2010 and 2011 will be better years to judge other
funds on their commitment to the payout, so nowholesale changes for now. In the interim we are
conscious that there are some outstanding funds
not featured here - see appendix 2 and the likes
ofBlackRock UK Income,JOHCM UK Equity
Income,Schroder Income.
We will make one change, switching out ofRathbone
Income and in toJOHCM UK Equity Income. The
JOHCM fund (yield 4.4%) has been outstanding in
total return terms in 2008 and 2009 (up 40% in 2009).
It is not easy for funds to offer something different inthe highly competitive equity income sector, but this
one does so. It is only 282m in size (with a cap of
750m to ensure it maintains its dynamism). It has a
similar yield discipline to theNewton Higher Income
fund, yet no stock is held for yield alone (as with
Standard Life UK Equity High Income andSchroder
Income). Unlike these excellent (but very large)
peers, this smaller fund can also gain a signicant
advantage from investing outside the FTSE 350
almost doubling the effective universe it can consider.
It already has a 15% exposure to small caps, where
the index weight is just 2%, so there is a signicant
opportunity to add value (to both growth and income).
Jupiter Income has just drifted off such that it has
no rating. However, this is a lot to do with high value
large businesses underperforming the dash for trash
in 2009 - hang on for now.
Newton UK Opps andArtemis UK Special
Situations continue to feature in appendix 2. After an
outstanding 2008, avoiding the worst of the banking
problems, the Newton fund stuck to its guns in 2009,
focussing on areas where there was obvious value.This meant that it didnt hugely benet from the dash
for trash from March 2009. But, as we said earlier,
the recent recovery in the UK stock market is only
sustainable if it broadens out and includes the value
stocks, particularly the large multi nationals, where
many of our fund selections have their focus, also
including theArtemis fund. So these funds are where
we want to be for 2010 and 2011.
OVERSEASLower riskThe adjustments last time worked well. By switching
out ofNewton International Bondwe achieved an
extra 5% of performance over the last 6 months of
2009 fromBNY Mellon Global Strategic Bond.
The BNY Mellon team remain optimistic for 2010;
they have a very wide brief (unlike many peer
funds which only buy government bonds) and at the
moment they hold 71% in global corporate bonds,which we regard as very positive.
Switching out of theMacQuarie infrastructure
fund and into the equivalent from First State also
generated an extra 2% of growth.
Infrastructure funds invest into businesses that
provide essential services and have relatively
predictable cashows, which should be sought after
in periods of uncertainty. Yet, as First State point out,
some infrastructure assets are positively exposed toa global recovery, so expect a volume recovery from
toll roads, airports, ports and railways, and some
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upside surprises to earnings. Acquisition activity, led
by the famous Warren Buffet, is also positive.
Last time we left theHenderson New Star
International Property fund in the table below as an
aide memoire, even though it was suspended, and that
we had recommended selling before that happened.
The latest news is positive, the fund has re-opened
to new business. Ironically the fund had been doingquite well in a turbulent 2008 - but once this was
spotted by investors, who then decided to sell, the
fund could not raise cash quickly enough to meet
redemptions. And this lack of liquidity is the key
limitation with bricks and mortar property.
Should you be buying now? Historically rental yield
is a key contributor to the long term performance of a
property portfolio. The yield on this fund is 3.1%, not
too bad, but not exciting either. On the other hand,
70% in the Asian Pacic region is encouraging. The
fund remains the only one of its kind available to UK
investors, and has been managed as well as possible
through a traumatic period for the world economy.
A key theme is 2010 being a year of transition for
the global economy - we would like to see how this
unfolds before recommending this fund.
Medium riskA surprising 6 months, withM&G American leading
this selection (up 26%), not the sector we would have
expected to rise to the top. But that is why it is a
diversied selection, because we (and no one!) knows
for sure - if we did none of us in here would need to
work for a living!
DIY OVERSEAS FUNDS
Co and fundGrowth last6 months
Sector Rating Risk Objective
grth inc
LOWER RISK
1 BNY Mellon Global Strat. Bond 9.2% Strategic Bond * y y
2 Stan Life Glob. Absolute Return 12.1% Absolute Return * y y
3 First State Glob. List Infrast. 22.4% Specialist * y y
MEDIUM RISK
4 First State Asian Property Secs 14.0% Property None 12.6 y y
5 Jupiter European Spec Sits 24.8% Europe Silver 10.8 y
6 Ignis Argonaut European Income 22.4% Europe Bronze 11.2 y y
7 M&G American 26.1% N. America Bronze 9.9 y
8 Schroder Tokyo 6.0% Japan Gold 8.7 y
9 Newton Asian Income 35.4% Far East excl. Jap Bronze 11.5 y y
10 First State Asian Pacic Leaders 23.0% Far East excl.Jap Silver 10.3 y
HIGHER RISK
11 M&G Global Basics 31.2% Specialist Silver 12.7 y
12 Axa Framlington Emerging Mkts 30.6% Global emerging Mkts Bronze 14.1 y
13 Jupiter India 34.8% Global emerging Mkts * y
14 Investec Global Energy 18.4% Specialist Silver 12.9 y
* Insufcient track record
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This M&G fund doesnt feature in appendix 2, but it
is a very respectable 2nd quartile over the 6 months,
and there is little difference between it and funds
featured in the appendix. So well stick with it.
Jupiter European Special Situations is more
difcult. If you were buying past performance you
wouldnt buy this fund; 4th quartile over the last
6 months. But you cant buy past performance!You must have an eye on what the next 6-12 months
might look like, and, as we have said elsewhere,
there should be more of a focus on nancially strong
businesses that can continue to grow, and gain market
share, through thick and thin - that is where this
Jupiter fund has its emphasis. Hang on for now.
For those that are a bit more conservative,
emphasising the income theme, we continue to
recommendIgnis Argonaut European Income,
yielding 5.5%.
We arent used to having Asia in third place in the
pecking order, but it is just behind North America
and Europe over the last 6 months of 2009. The First
State Asian Pacic Leaders fund continues to feature
in appendix 2, but has underperformed sharply in the
last year. The fund has a very conservative stance as
the manager believes there is little upside at current
valuations. In this year of transition that caution
appeals to us. Newton Asian Income is being added
for reasons set out on page 31.
First State Asian Property Securities (so property
shares not bricks and mortar) had a more subdued
2nd half of 2009, up only 14%. Where the Asian
economies go, bearing in mind they have relatively
little debt, so will their property markets. Hold.
Schroder Tokyo continues to feature in appendix
2. Opinions are widely divided on Japan - some
see considerable value, others foretell another ugly
downward lurch. There is some remarkable valuein Japan, and if the global recovery persists we
continue to believe the Japanese stock market has the
ingredients to surprise on the upside.
Higher riskThe higher risk funds are either emerging markets,
or commodities, or sub-sectors such as Japanese
smaller companies. In the last edition we suggested
taking some (handsome) prots on theJPM Natural
Resources fund, and it is up a further 40%. A
(surprisingly) strong dollar in the next 6 months may
well upset the commodities market, and as such we
would now sell this fund, and sit on the sidelineswaiting for another chance to get on board. We can
see no point sitting on huge prots and waiting for the
market to take them back from us.
In contrast oil/energy was relatively subdued, but
there is more obvious value. Sit tight withInvestec
Global Energy for now.
TheJupiter India fund is up another 34%. We dont
believe the market is too overvalued bearing in mind
the potential, not just next year, but for many years.Nonetheless, as rates are raised to curb inationary
pressure it will give investors the excuse to take
prots - take yours before they do!
Axa Framlington Emerging Markets has again
outperformed the emerging market sector over the
last 6 months.M&G Global Basics (the thinking-
mans way to access the positive trends in emerging
markets) has also continued its bounce, up 35%.
For new money, dripping into your chosen funds isan ideal way to build your exposure to these higher
risk funds. If you have lump sums we can arrange
to drip this into your chosen funds, perhaps over
6-12 months - ask for details.
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For clarity, do bear in mind that this model
assumes that you are going to build your portfolio
now, from scratch. As such the individual fund
choices will change from one edition to the next.
For those that have existing portfolios, and to help
put changes over the last 6 months in perspective, we
identify those changes in the text below.
New clients, previously with a rag-bag of holdings,
and too many dud funds, have had portfolios
transformed into something with a clear purpose and
structure with the help of this model.
The model might help you reect on the funds youve
accumulated over years (whether portfolio, pensions/
SIPP, or PEP/ISAs), and provides a template for
putting together a portfolio, perhaps for a SIPP.
If your attitude to risk has been properly identied,
and then adjusted for circumstances such as yourage, it should be possible to structure a portfolio full
of quality funds with proven track records, and you
shouldnt need to adjust these fund choices too often.
Of course if you want to chase the funds doing well
each month or quarter, this guide and its approach is
not for you. Even the professionals dont do this very
well - they are either chasing an established trend of
uncertain further duration, or trying to anticipate short
term trends, both of which are problematical. But
base your selection on sound principles that work inthe long term, and you shouldnt go too far wrong.
To this end well now consider:
what is the ideal fund?
what should be the asset and geographical split?
what is the objective with each part of the
portfolio?
The ideal fundis one that consistently provides
above average gains by taking below average risks.
Some other funds may be higher risk, but provide
such consistently higher rewards that they can also be
recommended. Our analysis certainly helps identify
both types of funds. It is not always a straightforward
job, as pure statistical analysis can overlook hidden
dangers, and these are the seeds of a funds future
volatility which we also try to identify.
There are a number of approaches to the asset and
geographical split. Over many years we have seen a
variety of reviews that, with the benet of hindsight
of the recent past, tell us you should have moreinvested overseas, then most invested in the UK,
or greater sums in the US. And computer models
are increasingly used to create the chimera of a
rational portfolio structure, but tell you nothing of the
accidents of history (see section 3.2), and lack the
input that only experienced practitioners can provide.
Obviously you must start by having a comfortable
sum on deposit or similar, that is no risk to capital
to cover emergencies, planned expenditure, and peace
of mind. With the rest of your investments, as you
get older you should adjust the balance, with more in
lower risk choices (e.g. bonds and property), and less
in stockmarket linked investments.
For example, you can apply a rule of thumb that the
low risk element of your portfolio should be equal to
your age. So if youre aged 25 the low risk holdings
would be 25%, and if youre aged 75 they might be
75% of your total investments. This is only a rule
of thumb, giving a structure for consideration - forexample, life expectancy is somewhat higher than
when this guide was introduced decades ago, so it
may be too cautious for some, for example, if you
have a secure and more than adequate guaranteed
pension. On the other hand personal circumstances
and your attitude to risk may make this cautious guide
just right for you.
Your overall objective will be matched against
the portfolio as a whole, but the objective (or
expectation) with individual elements of the portfoliovaries. The low risk element is the stable core, and
we would expect returns at a margin over those
available on deposit returns, but not a huge margin.
6. A model portfolio
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The extraordinarily high returns from xed interest/corporate bond investments in 2009 were exceptional
and will not repeat any time soon. However, there are still clear opportunities. To provide greater balance in
this element of your portfolio you should consider bricks and mortar property funds, global bonds, and new
opportunities as they arise, such as absolute return funds, infrastructure, and protected funds - remember, the
expectation is lower risk as well as lower reward.
The medium risk element, at its long term core, is focussed on high yielding UK equity income funds, for
reasons regularly set out in this publication, and all the more attractive right now, with interest rates close to zero.
In the long run we should expect returns at a margin over corporate bond funds and ination, and total returns
(that is growth and dividends) to be in high single gures.
The high risk funds hold out the potential for double digit gains, but with somewhat greater volatility being the
price. We look to generate this primarily from the Far East, emerging markets, and alternative asset classes such
as commodities. Dont forget to consider our risk denition in section 3.3.
Our model is designed for a 50 year old, whose objective is growth, and who is comfortable with medium risk
investments.
RISKMonthly
Risk (%)
FUND Style Cap Notes
LOW (1)
(50%)
3.2 M&G Corporate Bond
9.1 Henderson New Star Sterling Bond
6.7 Artemis Strategic Bond
6.1 Henderson Strategic Bond
7.2 Schroder Monthly High Income
n/a BNY Mellon Global Strategic Bond
MEDIUM
(30%)
11.2 JOHCM UK Equity Income value large
7.9 Newton Higher Income value large
9.4 Standard Life UK Equ High Inc blend large
10.3 M&G Recovery blend large
8.9 Artemis UK Special Sits value mid
11.2 Ignis Argonaut European Income
11.5 Newton Asian Income value large
10.3 First State Asia Pac. Ldrs. blend large
HIGH
(20%)
12.7 M&G Global Basics blend mid
12.9 Investec Global Energy blend large
14.1 AXA Framl. Em Mkts blend large
(1) We would occasionally include a protected fund in this lower risk portion, but offers are for limited periods so we have not specied
a fund. See more on protected funds on the next page.
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This is a portfolio for someone who wants growth
about two-thirds of those who hold corporate bond
funds do not take income, so this model is aimed at the
majority of investors whose objective is growth.
It is a medium risk portfolio, for a 50 year old, taking
at least a 5 year view, and ideally 10 years. Medium
risk was dened back in section 3.3. The age is
signicant. Our guideline is that your portfolio should
have an amount in lower risk investments equivalent to
your age so the older you get, the less risky becomes
your portfolio. This portfolio therefore has 50% in
lower risk investments.
It is diversied. If you look backwards there is no
one super asset or super fund that delivers high,
positive, above-average returns year in and year out.
So diversication is required across assets (e.g. equities
and bonds), across styles (value and growth), and
across continents (e.g. UK and Far East), because youcan never be sure where the positive growth will arise
from year to year.
Those are the key elements of our model, and we
anticipate some questions:
Changes since last time?We introduced more
corporate bond funds a year ago as they had more
bounceability than other lower risk funds, and we
increased this exposure 6 months ago (Henderson New
Star Sterling Bondand Old Mutual Corporate Bond),achieving considerable outperformance as a result.
Generally speaking there are three reasons why we
might change funds in this selection:
to increase the potential
to protect the current value
or because a funds performance has slipped and
there is a better fund doing the same thing
So last time we noted that the performance of the
Newton International Bondhad begun to slip, but
also that conditions going forward were not going to
be easy for global government bonds where this fund
has its focus. So we switched to its stable mate fund,
BNY Mellon Global Strategic Bond, which has a
much wider brief, (including government and corporate
bonds), and we got an extra 2% of performance over
the 6 months - it doesnt sound much but if you did that
every 6 months it makes a huge difference to your long
term performance.
In the medium risk selections, last time we noted that
in the UK equity income sector, some funds are more
aggressive than others, often funds that are smaller in
size, one such beingJOHCM UK Equity Income. We
didnt add it then, but we should have! We are adding
now, replacing theJupiter Income fund.
There are violently opposed views on Japan, but on the
face of it we believe there is considerable value at the
level of individual businesses. However, in this model
portfolio we would rather increase our exposure to Asiaexcluding Japan, both for its potential bounceability
out of any turbulent periods, and because, in the case of
theNewton Asian Income fund which replaces it, we
our buying into the long term rising demand for income
(see section 4.1) .
Bounceability wasnt just an issue in bonds a year ago,
which was why we selectedJPM Natural Resources.
However after it was up 60% at best in the rst 6
months of 2009 we took prots and switched to the
less spikeyInvestec Global Energy and M&G GlobalBasics. With the benet of hindsight we lost a bit of
performance over the last 6 months by this switch,
though these two funds were still up 19% and 31%
respectively.
Should you use protected funds (structured
products)? Yes, when available. In the past the lower
risk portion of your portfolio has been thought of as
corporate bonds and gilts, but there is more to consider,
including protected funds. From time to time products
are offered by investment houses where at a given point
in the future, usually after 5 or 6 years, 100% of your
original capital investment will be protected. The terms
of each need to be carefully considered.
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Why so many income funds? Many analysts
believe that total returns (that is capital growth plus
dividends) over the next 10 years could be just 6-8%
per annum. If so, a fund investing in shares yielding,
say, 5% (providing it appears reasonably secure)
generates a good chunk of that total return before any
capital growth comes through. TheNewton Higher
Income fund currently enjoys a yield of 7%.
Why so much high risk? The equity income funds
are relatively conservative ways to invest into the UK
stockmarket, though arguably the optimum way to do
so. If the total returns from the mature stockmarkets
(capital growth and dividends combined) are to be
modest in the years ahead, averaging, say, 6-8% per
annum, the boost to growth will come from the Far
East and the emerging markets, plus commodity funds.
But vigilance is required , and you must not be afraid to
step to one side from time to time, when valuations are
very high or some unusual new risk has arisen.
Is it too low risk? Up to you. If you are aged 60 with
a secure ination-linked pension, 100,000 on deposit,
and an investment portfolio of 100,000 (including
ISAs), you certainly might take on more risk than our
guideline suggests, which would have 60% in lower
risk investments. Would you be comfortable with more
risk? Thats where our advisory service can help, as
we can provide tailored assistance.
How do you measure the performance in the future?The key to this portfolio is that it is tailored to the
needs of our imaginary 50 year old. Beyond this, the
minimum target for future performance is that, on
average from year to year, you earn more than you
would have done on deposit and beat ination.
Otherwise we will measure the performance of the
individual funds within their respective sectors, to
ensure they are doing what was expected of them
i.e. consistent above-average performance in their
respective sectors.
Is this model like a fund of funds or multi
manager? Funds of funds have become very popular
in the last year or so. In essence the manager of the
fund of funds decides what funds to invest into, and
has a discretion in doing so. This is just like any other
fund in the sense that you have no relationship with
the manager, so the ongoing structure of that fund
takes no account of your personal objectives. You
will typically also pay extra charges for this extra
layer of management. Our model is very different as
it is designed solely for you (or at least our ctitious
50 year old) and it involves no extra charges to you.
We have gone through a process to identify a pool of
funds that we are comfortable including within client
portfolios, and the model is the distillation of this for
one particular person.
If you feel that your portfolio is a bit disorganised, do
get in touch for a helping hand - ring 020 8467 1666
NOTESNotes 1 and 2: cap refers to the average market
capitalisation of the companies in which the fund
invests. This is important because the behaviour of
large companies differs from small ones. Style refers
to the way companies are valued. Some companies
appear expensive in relation to current earning power but
provide excellent growth opportunities: known as growth
companies. Others trade at a low multiple to current
earnings but are not expected to grow: these are called
value companies. The style of some funds is to investinto value shares, others into growth.
Source: www.morningstar.co.uk
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