Getting the balance right

Keiron Root considers how to assemble a winning strategy for
your ISA investments.

Ok, so you want to make the most of the tax-free investment allowances that the government offers you, how do you go about it ? Paul Ilott, Senior Investment Adviser at Bates Investment Services, argues: “The first step is for investors to understand what they want to achieve from their investments, the timescale they are looking to invest over and whether there is a specified level of growth that they need in order to achieve their objectives. They also have to set out their stall as to how they might monitor their investments going forward, whether they want someone else to do that for them or whether they could do it themselves.”

He adds “If they want an active involvement in their investments, then they should be prepared to actively select and change the underlying fund holdings periodically. Otherwise, they might want to hand that responsibility over to an IFA or, alternatively, even invest in a multi-manager fund, where they are handing over the entire responsibility for running the underlying funds to a third party.”

The most important aspect of putting together an investment strategy for your tax-efficient investments is not to see them as distinct from the rest of your financial planning. Patrick Connolly, Research and Investment Manager at financial advisers John Scott & Partners, observes: “I would say that it is a mistake to look at your ISAs in isolation. What you need to do is look at them as part of a bigger picture with all your other investments as well. And when you are looking at asset allocation, you shouldn’t just be looking at the asset allocation of your ISAs, you should also look and see how that fits in with your other investments.”

Anna Bowes, Savings & Investments manager at Chase de Vere Investments, insists: “You need to ask how long you are going to be leaving your investments and then you leave cash for short-term expenses with the rest for medium to long term, in things that are non-cash based. You then decide on your objective – is it income, or do you want growth now for, hopefully, income in the future, or is it growth now for a specific requirement in the future. This will give you an idea of what sort of investments you need. Then you need to look at the sort of risk you want to take.”

She adds: “You want to use your ISA allowance in the most tax-efficient way. If you have a portfolio with some growth, but you are not going to have a capital gains tax problem and an income is important so you have fixed interest funds within your portfolio, for example, then you would probably want to wrap up your fixed-interest investments in ISAs because that will provide you with tax-free income. That is a strategy that can work in conjunction with your pension, for example,.”

Patrick Connolly points out: “One of the problems of the traditional ‘ISA season’ approach, is that people tend to leave their investments until quite late. Then, rather than investing in the right area to match their overall risk and their overall asset allocation, they often invest in ‘flavour of the month’ funds – funds that have been heavily promoted and that are promoting good performance, and funds with a fair amount of hype attached to them. In these circumstances, it is very easy to make the wrong decisions.”

He adds: “The key is not to pick individual funds. The key is to get the right overall balance. Of course, you can look at individual funds beyond that, but don’t make the mistake of thinking, ‘I fancy a bit of China, so I’ll pick a Chinese fund’. It is a case of looking at the overall picture and asking where you should be getting more exposure or changing the level of exposure that you already have.”

Gillian Cardy, Principal of IFA Professional Partnerships feels that the best way to get a grip on your diverse PEP and ISA holdings is to use one of the fund supermarket platforms that can bring all your holdings together in one place. She says: “I would start off by using one of the consolidation platforms, so if you are talking about going direct, you probably talking about Fidelity Funds Network or perhaps something like Hargreaves Lansdown’s Vantage service. That would for be direct investors. If people are going through IFAs, they might will get put in touch with something like Cofunds as an alternative.”

She adds: “The reason for doing that is that you don’t have to stick to one fund management company in any one year, so you don’t have to commit your £7,000 to any one fund management group. You could do one bit with, for example, Mark Mobius’ global emerging markets fund and then another with Neil Woodford’s income fund, which you wouldn’t be able to do if you were just limiting yourself to one fund management house’s ISA product. And then, as the portfolio grows, it makes it easier to manage the asset allocation, You can manage what is going on and then it is usually cheaper to switch, if you are switching out of a fund that is now underperforming. Or if you are building for growth now, but perhaps want to gradually switch to income in the future.”

Justin Modray, head of communications at financial advisers BestInvest, feels that a broad spread of investments is the right approach for most ISA investors. The problem is that many of them make their decisions on an ad hoc basis, year by year, and so end up with a very unbalanced portfolio “For a lot of people, it will make sense to have a range of funds across the board. Assuming that you have got several years’ worth if ISAs already built up, what is important with a new investment is to see how that complements existing funds you may have. So, to give an example, if most of your funds are UK stock market funds, and you have gone for some trackers and well-known household names, the chances are that your ISA portfolio is going to be UK stock market and large company biased.”

He continues: “Now, whilst that is not too bad a situation to be in, there are times when small and medium-sized companies do tend to perform better, and that has certainly been the case over the last few years. So in that situation, you might want to give some thought into going into funds that have a small or medium sized company exposure or bias instead. Not only may that give you better returns, but it also helps to balance risk, so it can help to reduce risk overall, even though, in isolation, they may be riskier investments than the ones you have already got. Because you are balancing two areas of the market it can actually reduce overall risk.”

Tim Cockerill, head of research at Rowan & Co Capital Management, feels: “You really have got a very large range of options to your ISA these days. I think the starting point has to be your risk profile and for a lot of investors, who have already got ISAs up and running, I think that every time they add to it, they do need to take a step back to assess the risk and assess their longer term strategy and keep their ISA portfolio as balanced as they can.”

He argues: “I think that the danger can be that, if you are an investor who adds, perhaps, to that portfolio once a year, you get drawn into following the latest fashion. Currently that might be emerging markets – China, India and so on – or it might be property, but the danger of that is that you end up with an ISA portfolio of holdings which have really been selected on the hoof. Which is why you need to take a step back and say ‘What am I trying to do, how do I construct my portfolio over the long term, what is my time horizon, what have I already got and where, perhaps, have I got gaps in my portfolio, which I would benefit from filling, because I am going to end up with a more balanced portfolio?’”

Gillian Cardy points out: “In the old days, investors tended to regard their PEP and ISA investments along the lines of ‘This year is the year I have done Fidelity and last year was the year I did Perpetual and the year before was the year I did Deutsche’. But if you take that approach, you get to a point where you have got to a portfolio of, say, £50,000, and it is really difficult to monitor how the funds are doing, how they are allocated and how the whole portfolio looks. Now that you have got those consolidation platforms there, it is much easier to watch what is going on, and if you have picked a fund that has now gone off the boil, you can make a transfer as an overnight switch from one fund to another, rather than having to go out of the market for a week or two.”

She adds: “So it makes the whole management of the process on a long-term basis much more straightforward. And it doesn’t cost any more. So even if you are only thinking of making limited ISA investments, not even putting in £7,000 year after year after year, why shouldn’t you just do it anyway – as it doesn’t cost any more to use these platforms – and they are very easy to use.”

Justin Modray points out: “If you have typically chased performance in the past, then you are probably going to have a portfolio of fairly racy funds. So you either might want to take a look at what you have got and make a few changes there, or you might just want to go for something safer this time round, just to again try to reduce overall risk to a more reasonable level.”

Tim Cockerill also stresses the importance of assessing your individual investment objectives. “Obviously, the shape that this portfolio takes is going to be dependent on a number of factors – how old you are, your time horizon, what level of risk you want to take, there being a big difference between someone who is 30 and someone who is 65, for example – but that has to be, for me, the starting point, because the danger of buying the latest fad in fund management will give you an unbalanced portfolio, and because of that you are going to have risks which, ideally, you don’t want.”

He also points out: “You can actually, in most instances, create a balanced portfolio with almost as much growth potential as one that is unstructured and has a bias towards, let us say, emerging markets. You have seen that China is dong well and that Chinese investments are doing well, you have seen that India is doing well, you have seen that Russia is doing well. That is why you need to take a step back and be sensible.”

Paul Illot concurs: “You need to know your objectives and, especially, the level of risk that you are prepared to tolerate. Also whether you require an income, either now or in the future, say in five years’ time. That might steer you more towards equity income type funds. Even though the income might not necessarily required immediately, it can be reinvested with the prospect of it being paid out at the retirement stage in a few years. ISA investments give you greater flexibility when compared to pensions in that you are able to get at 100 per cent of the underlying funds, rather than being restricted to 25 per cent under the pension regime, and also being able to pass over the underlying funds to your estate on death.”

There is also the question of whether you can make these sorts of decisions for yourself or whether you will need to use the services of a financial adviser or stockbroker. Perhaps unsurprisingly, John Scott & Partners’ Patrick Connolly thinks that seeking advice is generally a good idea. “Our view is that the vast majority of people probably shouldn’t be doing it themselves, because they haven’t got the time, the resources or probably the knowledge to do that. Now I’m sure that there are many individuals out there that would disagree with that and claim that they are able to do it themselves, but in terms of the client’s portfolios that we see, very often they are out of kilter with their risk profile and typically that means that they hold too much in equities. That is why your ISA needs to be considered as part of your overall range of investments, to make sure that it matches your risk profile and will hopefully achieve your objectives.”

Gillian Cardy points out: “If you are buying directly, say, buying online, you need to think carefully about the risk ratings that some companies give their own funds. So do your own research and come to your own conclusions about whether a fund suits your risk profile or not. For example, a professional money manager does not regard smaller companies funds are either high risk or low risk. They will see small-cap funds as moderate risk, because that is what they know and that is what they do all the time, whereas the understanding of more normal human beings is that small-cap funds are quite high risk. So make sure you are using your own definitions of what you would consider to be low, medium and high risk, not how a fund management company has translated that. Don’t just take ‘low risk’ at face value.”

Paul Ilott stresses: “The other thing that investors need to address, once they have looked at their aims and objectives, timescale and risk tolerance, is to set out the rules for their portfolio, because by setting those rules out in advance, it enables then to monitor their portfolio more easily as time progresses. So for example, the rules might set out how much exposure you want to have to equities, as opposed to fixed interest, or even to commercial property or more specialist investments that you might find in the IMA specialist sector, for example, technology, natural resources or single-country funds. It is wise to set out your stall well in advance of putting your portfolio together, so you are creating the framework to put your funds into.”

He adds: “So the bare framework might be 50 per cent in equities, 35 per cent in fixed interest and the rest in a mixture of property and specialist funds, but the proportions are really down to the individual investors, what they want to achieve and the amount of risk that they are prepared to take, as to what the appropriate mix might be.”

Ilott continues: “Then, having got that framework, it makes it slightly easier to start populating it with appropriate funds. It also means that, given time, the funds will grow outside of that framework, because two or three funds will start to outperform the others, so the portfolio will become skewed from the original position. But having set the framework out, investors have something to benchmark their portfolio against in future years, and be able to tilt the portfolio back into the original benchmark, if that is still appropriate.”

He explains: “This enables you to keep control of the risks of your investments because it is likely that, over the longer term, the equity funds within your portfolio will outperform the rest and, if that happens, as time progresses, more and more of the portfolio will be weighted towards equities and, therefore, as an investor, you will be carrying more and more risk.”

Anna Bowes emphasises: “One other thing – the term ‘asset allocation’ has definitely become popular over the last few years. What it is trying to achieve is a situation where, by reviewing your investment portfolio every year, potentially, you are going to be selling those investments that have done well and putting the money you have made back into those investments that have not done so well. So you are keeping your portfolio balanced within the same risk profiles that you started with. If you do it correctly, it will help you achieve the investment goal of selling high and buying low, as opposed to selling low and buying high, which is what most people do because it is human nature to do it that way. So, once you have got your ISA portfolio, make sure you keep reviewing it.”