- Investors looking for ISA ideas have plenty of choice on the UK market for growth, value and income styles
- It is wrong to dismiss the UK as being ‘old economy’ given there plenty of modern, dynamic companies?
- Three UK-focused funds and investment trusts investors may consider
Dan Coatsworth, investment analyst at AJ Bell, comments:
“Funds and trusts that invest in UK-listed stocks typically follow certain investment styles and sometimes they blend them together. Managers typically have a value, growth or income bias. Value investing means looking for stocks trading below what they think a company is really worth. Growth investing means finding companies which are growing earnings at a decent rate. Income investing is about picking stocks that can deliver a regular stream of dividends.
“Sometimes a fund manager will look for both value and growth, essentially meaning they want to pick companies whose valuation is fair or cheap and capable of delivering good earnings growth. This is often referred to as a GARP or ‘growth at a reasonable price’ strategy. Income funds and trusts tend to have a value bias because generous dividends are often found in mature companies that trade on cheap valuations due to having lower growth rates.
“In addition to style, a fund or trust may restrict their search for opportunities based on a company’s size. Funds or trusts in the ‘UK All Companies’ space can look for any size business, but they will typically concentrate on larger ones. Some funds and trusts specialise in mid-caps which simply means they pick stocks from the FTSE 250 index; others look at smaller companies.”
Which ones to put in an ISA?
“Investors should consider what’s already in their portfolios and whether adding UK-focused investments to an existing ISA will add a new dynamic or not. For example, someone with a global tracker fund might add a UK smaller company fund if they share the view that small caps have been unloved for several years and could bounce back once interest rates start to be cut. Another person looking for income-generating investments might explore opportunities with a UK fund because yields are often greater than you find in other parts of the world and valuations cheaper.”
Flavour 1: Value
“Investors will need to hold their nerve if putting money into value funds or trusts. It can take a long time for the market to recognise a successful turnaround story or special situation, and sentiment can stay weak towards unloved companies for ages. Stay patient and the rewards can be spectacular if the fund or trust has picked the right ones.
“Temple Bar is one of the most popular investment trusts for investors seeking value opportunities. The managers often hold stocks that the average person might think to be broken businesses or ones that have lost their way, such as previously owning a stake in Royal Mail-owner International Distributions Services.
“The Temple Bar managers pick stocks where they think the market hasn’t recognised the true value in the business. This might be owning a division that could potentially be worth more than the market value of the entire group or where the market is simply being too pessimistic and the stock could eventually see a positive re-rating. Names currently in the portfolio include Shell, NatWest and Marks & Spencer.
“Fidelity Special Values is also a contrarian investment vehicle, owning shares in unloved companies which in the managers’ view have the potential to change. It invests when sentiment is poor and sells once the market has recognised the turnaround and investors are buying into the growth story. Unloved companies are typically priced on a low valuation, so Fidelity gets in cheap and sells when the rating is higher.”
Flavour 2: Growth
“Investors with time on their side often feel comfortable taking higher risks in search of higher returns. That can involve backing companies with strong levels of earnings growth. Remember that earnings growth can be a major share price catalyst.
“There is a misconception that growth investing is about backing start-ups with bright ideas and no sales or profits. These so-called ‘blue sky’ situations can feature in growth portfolios, but they tend to be the minority. Instead, you’re more likely to find portfolios that feature profitable companies with big opportunities to grow earnings and market share. Also on offer, albeit on a smaller scale, will be less mature companies which have already commercialised an idea but are still in the early stages of their growth.
“Liontrust UK Growth’s aim is to beat the UK market, as measured by the FTSE All-Share index. The managers look for companies that have a competitive advantage such as through intellectual property, recurring revenue or strong distribution networks. The fund has a bias towards companies with quality characteristics and will only invest in profitable companies with a robust balance sheet. Portfolio names include pharma giant GSK and defence group BAE Systems.
“Many investment trusts invest in privately-owned companies as well as those trading on a stock market. These ‘unquoted’ business are often less than 10 or 15 years old and are disrupting industries that have been dominated by the same names for decades. As such, it is common to see rapid sales growth as they grab market share as consumers or businesses seek a fresh alternative to the status quo.
“This is exactly the strategy at Chrysalis Investments – it seeks innovative companies with the potential to disrupt sectors. Its portfolio includes stakes in UK firms Starling Bank, marketing specialist The Brandtech Group and Featurespace, which uses software to help in the fight against fraud and financial crime. Chrysalis isn’t a pure play on the UK as it also invests in certain foreign firms including Swedish buy now, pay later giant Klarna.”
Flavour 3: Income
“The UK market is blessed with lots of income opportunities, many of which pay higher dividend yields than you might find in other geographies such as the US. That is music to the ears of people in retirement who might be reliant on their investments to generate an income to pay the bills.
“A lot of the UK equity income funds are concentrated in the same group of stocks, principally in the banking, oil and life insurance sectors where some of the most generous dividends can be found. Earnings growth is low or unpredictable in these sectors, hence why companies use generous dividends to make their shares attractive to investors.
“City of London Investment Trust has a blend of value and income for its investment style. Its 0.37% annual charge is among the lowest in the UK equity income space and a 5% yield is higher than the FTSE 100 which offers 3.9%. One can understand why this trust is so popular among investors given this enhanced yield, with City of London regularly featuring among the most bought investment trusts on the AJ Bell platform.”
Three UK-focused funds and trusts investors may consider
“Certain investors may want to pick funds and trusts based on other factors than simply picking a value, growth or income style. Some might want to ensure they only invest in companies doing good, others might want a ‘cream of the crop’ selection from the market or even something unique which you cannot find elsewhere.
“Each of the following funds and trusts outperformed the FTSE All-Share index of UK companies over a three, five and 10-year basis and have qualities that make them stand out from the crowd. However, investors need to consider how much they should allocate to the UK and maintain a geographically diversified portfolio.
“Past performance is not a guide to future performance but looking back over history can help to spot funds or trusts that have demonstrated stamina and prowess. It’s important to look over a long period such as 10 years to separate those which have skills versus those which might have just got lucky over the short term.”
- Backing companies that do good – Royal London Sustainable Leaders
“This fund might suit someone with strong views about the type of companies they do and do not want to invest in. It focuses on companies that have a net positive benefit on society via their products and services or in the way they do business.
“What you don’t get is exposure to activities such as nuclear power, weapons manufacturing or animal testing for non-medical purposes. Some of the key holdings include AstraZeneca, London Stock Exchange and Compass.”
- Best ideas from the FTSE 350 – Artemis UK Select
“Think of this as a ‘best ideas’ of the FTSE 350, with about three quarters of the fund held in large UK companies and the majority of the rest in medium-sized businesses. The manager has a simple premise: find companies that could get a lot bigger over time and then whittle down the selection based on a corporate’s health and prospects.
“The portfolio includes quite a few banks and oil companies like Barclays and Shell, while the industrials sector is also a favourite hunting ground. The fund can bet against companies it thinks will struggle on the stock market through a process called shorting.”
- A growing stream of income – Law Debenture
“This is an investment trust with a twist. In addition to running a portfolio of UK stocks, Law Debenture also provides services to corporate trusts and pension trustees. This provides an added diversification that ensures the performance isn’t solely reliant on the direction of the stock market.
“The professional services arm provides an important revenue stream that supports the payment of a higher dividend without constraining the manager to focus exclusively on higher-yielding stocks.
“The 4% dividend yield is less than top-paying cash accounts at present but savings rates are expected to trend lower this year if the Bank of England cuts the base rate. In comparison, Law Debenture looks for consistent income growth and has achieved 7.9% compound annual growth in its dividend over the past 10 years.”