Where in the world should you invest your annual share Isa allowance? These days, the only limitation is your attitude to risk. But which of the emerging economies, such as Brazil, should you choose for the maximum profit — and which are worth avoiding?
Wherever in the world you want to invest, it makes sense to do so through an Isa. In this tax year, you can put up to £11,280 into a share Isa as long as you don’t also have a cash Isa. For the 2013-14 tax year this rises to £11,520. Investing in an Isa means you won’t pay tax on any growth in your underlying investments. But the tax advantages these days are fairly minimal. You should never put money into an investment Isa solely for the tax purposes: an investment should make sense even if it were outside the Isa framework.
However, if you are prepared for the higher risk that share investing offers compared with cash Isas, we have examined all the major markets and what each offers to investors and which funds Britain’s top investment advisers favour in each region.
Emerging markets as a term covers much of the globe from the rapidly emerging Bric economies Brazil, Russia, India and China to the wilder shores of the frontier markets including the Middle East, Africa and the less developed South and Central American countries. China, the most populous country on Earth, deserves its own examination.
Darius McDermott, managing director of Chelsea Financial Services, said: “Emerging markets are a higher risk, but over time that risk is lessening. These markets are more volatile; the corporate governance is not as good and there is a little more political uncertainty. But those are the negatives. The upside is that they are growing and have huge potential. But any investment in emerging markets should be for the long term and regular savings can also reduce volatility.”
Jason Hollands of Bestinvest added: “Global emerging markets are one of the three areas the others Europe and Japan which we think represent good value at the moment. The long-term growth story behind these markets is reasonably well understood by investors; they have positive demographic trends of young and growing populations, affluence is spreading and with it demand for consumer goods.’’
Danny Cox, head of financial planning at Hargreaves Lansdown (LSE: HL.L - news) , agrees. “ Over the past couple of years, success in developing economies has not been reflected in their stock markets and could present an opportunity for adventurous investors happy to take a long-term view.” Ben Yearsley of Charles Stanley Direct adds: “In the long term, you have to be in emerging markets.”
Figures from statisticians Morningstar (NasdaqGS: MORN - news) show that for the Global Emerging Markets sector the best performing fund over both a year and five years is Aberdeen Emerging Markets. This fund has turned £1,000 into £1,258 over a year and £2,377 over five years. The average fund in the sector has turned £1,000 into £1,067 over a year and £1,378 over five years. However, Aberdeen earlier this month “soft-closed” this fund by imposing a 2pc initial charge to deter new investors because it doesn’t want the fund to grow even larger.
Advisers all rate First State Global Emerging Markets, which is still open without any bars to investors although First State has in the past soft-closed emerging market funds. The statistics show a £1,000 investment in this fund would have grown to £1,188 over a year, £1,874 over five years and £5,960 over 10 years. The fund, which has £3.5bn under management, is currently around 13pc in South Africa, 11pc in South Korea with a similar amount in Taiwan. Mr McDermott also likes M&G Emerging Markets.
The First State fund is in more established emerging markets. But for those willing to walk on the wild side, there are single country funds and those in the frontier markets. Of the Bric countries, investing in Brazil is taking a position on commodities. Russia the cheapest Bric market is heavily linked to the oil price. Mr McDermott said: “I think India has the greatest potential. It’s got a fast- growing middle-class educated population, although there is a political risk.” Frequently-mentioned single country Bric funds include Jupiter India, Neptune Russia & Greater Russia and Aberdeen Latin American Equity, which is 66pc in Brazil.
Mr Hollands adds: “For those investors prepared to allocate a small amount of their Isa to something very high risk then frontier markets such as Vietnam, Nigeria and UAE could be interesting over the very long term. We like the Templeton Frontier Markets fund, managed by Dr Mark Mobius.”
Regular saving is a good option rather than lump-sum investing. And emerging markets should not be more than a small percentage of your portfolio. These are risky markets: while the funds mentioned have done well, you can easily lose money. Single-country funds in particular are only for the bravest.
The market in China is up 24pc since September. ''But it’s an odd market,” says Mr Yearsley. “It’s completely state-controlled. Currently the government is planning to improve the wealth division in the country, because at the moment the west is much poorer than the east.” Mr Hollands said: “While the leadership transition appears to have gone smoothly and fears of a hard landing for the Chinese economy have receded, we are cautious on China as the economy is fundamentally imbalanced with too much reliance on infrastructure projects and exports, and faces formidable challenges including rooting out corruption and addressing social and political unrest.
“We are also concerned about the banking system in China. Bad debts have started to rise and a sprawling shadow banking system has emerged, the scale of which is unclear, which may come back to bite.” He added: “ We urge some caution and would not recommend investors use China-specific funds but instead invest via a broader-based Asian fund.” He likes Schroder Asian Alpha Plus which is 29.9pc in Hong Kong listed shares and 10.4pc in mainland listed stocks “so it plays the China theme but has capacity to look elsewhere”.
Mr Cox points out that the Chinese government has stimulated growth with interest rate cuts and increased infrastructure spending. He added: “As China reduces its reliance on exports and rebalances towards domestic consumption, lower-value manufacturing could move to other emerging regions, boosting their economies. A potential hard landing continues to loom. However, the authorities could introduce further measures to boost economic activity.’’
Figures from Morningstar show that had you invested £1,000 a year ago, then in First State Greater China you would now have £1,200, while over five years it would have grown to £1,797. There are only 20 funds in this sector, and all have produced positive returns over one and five years.
Favoured funds include Invesco Perpetual Hong Kong & China, picked by Mr McDermott and Aberdeen Global Chinese Equity, chosen by Mr Yearsley. Mr Cox chose Jupiter China: “A bias towards smaller and medium sized companies in the domestic Chinese market makes this fund more volatile than many others in the sector. This made it vulnerable to souring sentiment towards Chinese equities. But after a long period of poor performance, the Chinese market appears to offer good value and there has been an upturn recently, which has benefited the fund.’’
Japan and the rest of Asia
Japan has had more false dawns than any other sector. But Mr McDermott has picked it as his tip for the year, and others see positive signs that the country might produce good returns . “Japan has been in the doldrums for 20 years. But the new Prime Minister Shinzo Abe has said he wants growth at any cost and is prepared to weaken the yen to do so.” Mr Hollands is cautious about Japan. “Many investors will baulk at investing in Japan given the boom-then-bust story of its equity market in the 1980s. Japan has an ageing population, has seen weak leadership which has failed to deliver reform, it has been involved in sabre rattling with China and its currency has been too strong, undermining competitiveness. In fact Japan has been so unloved its shares are very cheap on any measure, with many companies trading below book value. Of course stocks can stay cheap unless there is a catalyst for change. And that is where Japan is starting to look very interesting given the recent landslide victory of the Liberal Democratic Party . This has seen the implementation of massive stimulus measures and policies to aggressively weaken the yen. The policy could lead to a sustained re-rating of Japanese companies.”
Favoured funds in Japan include Jupiter Japan Income and GLG Japan Core Alpha. The best performing Japanese fund over the past one, five and 10 years is Neptune Japan Opportunities which would have turned £1,000 into £1,736 over five years: the average in the sector is £1,174 over the same period.
For those wanting to look east but not just at Japan, the Asia Pacific sector (both including and excluding Japan) offers opportunities. The favoured fund is probably First State Asia Pacific Leaders, a £6bn-plus fund with big investments in Hong Kong, Australia, Korea and Taiwan. It’s showing an increase of around 70pc in the past five years.
January 2013 was a record month for the UK stock market with the FTSE All Share rising a huge 6.37pc. Our home market must surely be the first choice for anyone wanting to hold an investment in an Isa. But investors might already be too exposed to the UK especially since the economy is hardly in robust health. Mr Cox said: “The latest GDP figures reaffirm our view that the UK economy is bumping along the bottom. Other statistics paint a more optimistic picture. Employment figures are relatively robust and the financial system appears to be slowly recovering, aided by low interest rates and quantitative easing. Further evidence of recovery should favour previously depressed, economically cyclical areas such as retail, house building and banks.”
And Mr Hollands questions whether anyone already invested in share Isas needs to put more in the UK given the poor prognosis for the UK economy. ’
But he says an investment in the UK is “essentially global in nature, so domestic economic woes should not deter investors.
UK equities, [it is] arguable, provide some protection against the weakening pound.
This is because around two-thirds of the earnings of the UK-listed companies quoted on the London Stock Exchange (LSE: LSE.L - news) are truly global in nature and their ranks have been joined in recent years by a number of emerging market commodity companies”.
However. the dominance of oil and gas companies plus the proliferation of banks in the UK index means that going for an index tracker isn’t such a low-risk option.
Mr McDermott suggests the best way for Isa investors to go into the UK may be to think small. “ Smaller companies are up 22.6pc over the past 12 months compared with 17.2pc for all UK companies.” For a pure smaller companies fund, he likes Marlborough Special Situations; for a mixed approach Axa Framlington Select Opportunities.
Mr Yearsley is upbeat on the UK. “We’ve had a massively strong run in the last four weeks. Remember this time last year the index was 1,000 points below where it is now and it now seems to have settled around the 6200-6300 level.” He added that while there were still questions about the UK economy, sterling’s weakness will help UK companies’ exports. “You need quality fund managers for this kind of market,” he says. He also likes Axa Framlington UK Select Companies the £3bn-plus fund is 44 years old and is run by the very experienced Nigel Thomas.
Mr Cox’s favourite UK funds include M&G Recovery . “This fund invests in unloved businesses with problems and that requires patience: it takes time for a company to stabilise and realise its full potential,” he said. “Around a third of the fund is in stocks such as Tullow Oil (LSE: TLW.L - news) and Aggreko (LSE: AGK.L - news) that have already recovered and are delivering good results for investors with the remainder invested in companies at an earlier stage of the process.”
He also picks Liontrust Special Situations the larger cap choice of Mr Yearsley too and also mentioned by Mr Hollands. This fund buys companies it believes to have an “economic advantage”. As a core holding if you don’t already have it, Mr Cox recommends Invesco Perpetual High Income. With more than £11bn under management, this fund is the largest in the UK.
The US had a good 2012, with its stock market performing well, property prices rising and the newly-re-elected president seeming to have got a grip of the economy. And surely the world’s biggest economy has got to be part of anyone’s portfolio? However, pure US funds are strangely unpopular. Few funds add any value over putting your money in a passive tracker fund. This is because the US is the world’s best-researched market which means there are few bargains to found .
And while the recent GDP figures were not as bad as feared, good news isn’t necessarily what investors want to hear. Mr McDermott said: “The S&P 500 is the least cheap market and is at a five-year high.” Mr Hollands said while the US economy may do well this year, and there is a “bright spot in the boom in the shale gas industry which offers the prospect of energy independence”, the expense of US shares makes him cautious.
Gary Dugan, chief investment officer, Asia and the Middle East for Coutts, said: “We are holding off from adding to our US positions.” He added: “Our view is unchanged the underlying trend of improvement in capital spending, the housing market and consumer spending remain intact. The recent sell-off in treasuries, pushing 10-year yields up to the 2pc level, was unsurprising, but further aggressive selling is unlikely in the near term.
“The GDP data and the Fed’s commitment to large-scale quantitative easing are at least partially bond-friendly. Conversely, equity upside may be limited in the near term with the S&P500 approaching its 2007 high. We would look for a more significant correction before adding to our US equity positions.”
Favoured funds for those wanting to buy into the American dream are Legg Mason (NYSE: LM - news) US Smaller Companies and trackers such as HSBC American Index or Blackrock North American Equity Tracker. The last two are passive funds that will simply follow the market. The Legg Mason fund would have turned £1,000 invested a year ago into £1,173 and £1,619 over five years. Mr Cox picked the Blackrock (NYSE: BLK - news) tracker adding: “The large cap US market remains driven by passive funds with many active managers struggling to add value. This tracker fund gives investors access to the US and Canadian markets.”
But Mr Yearsley has a different approach: “I buy into the US through technology funds, which are usually at least 50pc in US companies.” His favourite is GLG Technology Equity, a fund with a 15-year pedigree and with more than 55pc of its current portfolio in US technology companies, including Apple (NasdaqGS: AAPL - news) .
Despite the turmoil in continental Europe, last year investors who put money in its markets did well: it was one of the best performing sectors, particularly in the second half of the year. And this year could be good too though it could easily become derailed.
Worries about a eurozone break-up seem to have been put on ice. And the tough stance of the European Central Bank has also pleased investors: it has bullishly supported the euro, strengthening the currency. However, the problems of the debt-ridden southern European nations remain. And with an Italian election on the horizon, there’s always a chance of Silvio Berlusconi re-emerging: “Any sign of him coming back would be disastrous,” said Mr McDermott.
Norman Villamin, chief investment officer Europe at Coutts, is fairly positive but cautious. “Although European fourth-quarter earnings are set to disappoint we expect the pace of earnings downgrades to slow in 2013 they could even be positive by the end of the year, given most of the bad news is priced in.
“Fears of a eurozone breakup have subsided, yet this is not fully reflected in consensus earnings forecasts. But the contrarian signs are there. Revision ratios, the number of upgrades versus downgrades, reached a nadir when markets were in crisis in June 2012, with only 23pc raising their forecasts. Since the European Central Bank president Mario Draghi publicly supported the euro with a 'whatever it takes’ policy, this has recovered to 39pc. This is a good signal; when revision ratios rise from their trough, markets often rally.”
But good company news would only outweigh the bad in the second quarter of the year “and elections in Germany and Italy this year could create some bouts of volatility. We are waiting on the sidelines as corporate earnings in Europe return to something more akin to normal, we would see any setbacks as a buying opportunity”.
Mr Cox thinks European equities “remain cheap relative to other asset classes”. But he said: “Europe has much work to do to restore its financial health, but lack of confidence in the continent over recent years has provided investors with some extremely attractive buying opportunities. Many companies in the region remain robust and have the potential to provide strong returns over the long term.”
Mr Hollands says compared with the US, European stocks are cheap: “The difference between European company P/E ratings and their US competitors is pretty much as high as it has been in a decade. “We think this must narrow at some point and believe large, globally diversified businesses that happened to be listed in Europe are an attractive opportunity. A couple of examples would be Unilever (NYSE: UL - news) , which earns most of its revenue in Asia, and brewer Anheuser-Busch inBev: a European business that owns America’s Budweiser.” His favourite fund is Threadneedle European Select while both
Mr Cox and Mr Yearsley plump for Henderson European Special Situations, run by veteran fund manager Richard Pease.