TopFunds Guide 17th edition January 2010, Dennehy Weller

8/9/2019 TopFunds Guide 17th edition January 2010, Dennehy Weller

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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

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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

part may be reproduced without permission


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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.

part may be reproduced without permission


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Copyright January 2010 Dennehy Weller & Co.

www.topfundsguide.com

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.



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.



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.

12 Copyright January 2010 Dennehy Weller & Co.



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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.

part may be reproduced without permission13


14/48



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



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.


18/48


19/48

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,


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%


20/4820


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


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.


21/48


22/48



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?


24/48

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.




25/48

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



26/48

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




27/48

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



28/48

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




33/48

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Documents

TopFunds Guide 17th edition January 2010, Dennehy Weller