Ten funds to pep up your portfolio in the new year

The bull market for equities that began back in March 2002 is expected to continue well into 2006. Despite the fact that global growth is slowing, investment experts anticipate that stock markets will continue to deliver good returns, both at home and abroad.

For investors who do not want to trade individual equities, collective funds are the ideal way to get exposure to global stock markets. Unit and investment trusts pool investors' money, with a professional fund manager responsible for selecting a diversified portfolio of stocks.

We asked five leading investment experts for their top fund picks both within the UK and away from home. The idea is to give investors a core UK holding as well as something more interesting.

Among UK funds, our panel of experts came up with very different funds to what they would have likely chosen in recent years, reflecting a shift in the types of companies that are most likely to deliver the best performance in the year ahead.

Since earlier in the new millennium, equity income funds have been the favourites of many advisers, on the grounds that dividends can play an important part in achieving strong returns.

As a result, funds such as Invesco Perpetual Income, Jupiter Income and Framlington Equity Income have been stealing the lion's share of independent financial adviser (IFA) recommendations in recent years.

Funds of this type would have served their investors well - they have been strong performers since the technology, media and telecoms (TMT) bubble burst in early 2000. However, now that market sentiment has improved, growth-oriented funds are once again coming to the fore.

As Justin Modray, an IFA at Bestinvest, points out, the UK stock market has favoured value companies over growth companies in recent years. Value companies tend to be those that pay out dividends.

However, these stocks have been so highly sought-after relative to growth stocks that they are now more expensive by comparison. Modray expects that growth areas of the stock market will benefit from the catch up period.

Another sea change in the UK market is that large caps have started to outperform small and mid caps, after lagging behind for several years.

Gavin Haynes, a portfolio manager at White-church Securities, says that while funds that are focused on smaller companies have fared well over the past three years, it now pays to pick funds with large cap exposure.

At a sector level, natural resources remains a dominant theme into 2006 even though these companies were among the best performers during the previous year. Nick Greenwood, an investment trust analyst at Iimia, believes that because of strong demand and underinvestment in exploration stocks by the larger oil majors, funds which focus on these companies should continue to fare well.

In terms of overseas funds, most investment experts believe that Japan and Europe will be the best performing regions over the year ahead. Most of the excitement is directed toward Japan, where a recovery finally seems firmly entrenched.

The current recovery is founded on change in domestic-focused companies, rather than being reliant on exporters, as has been the case in the past with the many previous false dawns in Japan, says Juliet Schooling, an IFA at Chelsea Financial Services.

Optimism over Europe is based more on companies getting themselves into sound shape after a period of restructuring, says Paul Ilott, an IFA at Bates Investment Services. He points out that while earnings growth in Europe is at a 15-year high, valuations remain attractive.

Juliet Schooling, Chelsea Financial Services

HOME: Invesco Perpetual UK Aggressive

Managed by Ed Burke, this fund has been the top performing of some 259 funds in the UK All Companies sector over the past three years (posting a return of 156.5 per cent over three years to 12 December, according to Standard & Poor's). Schooling expects that the outperformance will continue.

As a highly concentrated 25-stock portfolio, this fund contains the manager's very best ideas, and Burke focuses on investing in companies that can achieve growth at a reasonable price. Large holdings currently include BT, Barclays and Rolls-Royce.

"Burke also combines his stock picking capabilities with a top down macro economic overlay to ensure he is always in the best sectors at a given time," she says. She believes 2006 will be a year of divergent returns, so good stock picking will be essential.

AWAY: Legg Mason Japan Equity

Finally there seems to be a genuine turnaround in the Japanese economy and this fund, managed by Hideo Shiozumi, should be best poised to capitalise on that trend, Schooling believes.

"Legg Mason Japan Equity focuses on the smaller cap end of the Japanese stock market, and has a bias toward companies focused on the domestic rather than export market," she says.

"It is among the smaller companies that most of the growth in the Japanese market will be achieved in the year ahead as these tend to be domestically oriented."

Schooling says deflation in Japan has finally ended. Meanwhile, balance sheets of companies are in good shape and there are the beginnings of a revival in the property market. In addition, wages are increasing as the employment situation improves.

Schooling adds that Hideo Shiozumi has a proven track record and is well qualified to continue delivering strong performance.

Justin Modray, Bestinvest

Home: Liontrust First Growth

Although this fund has lagged its peer group during recent years, Modray expects the stock market will favour the investment style of the manager, Jeremy Lang, during 2006. Since early 2000, value-oriented companies (which pay out dividends) have outperformed growth companies.

The latter - technology companies are a good example - reinvest their cash back into the business with the aim of making them more profitable further down the track.

However, because growth companies have been out of favour for this reason, they are now cheaper than their value counterparts. Therefore, Modray expects strong performance from growth stocks as they catch up to the rest of the market. "Lang's growth style has suffered in recent years because of his out-and-out growth style at a time when value-oriented companies have taken the lead, but with the market swinging back toward favouring growth-oriented companies, we expect his style to work well in 2006," he says.

AWAY: Legg Mason US Equity

Modray says it seems that interest rates have now peaked in the US, which should give some breathing space to the stock market.

Meanwhile, the US economy is in reasonable shape and companies are profitable. He says the manager best positioned to capitalise on the strong US market is Legg Mason's Bill Miller.

Although the Legg Mason US Equity fund has only been available to US investors since January 2003, Miller is well known for being the only manager to outperform the S&P 500 index for 14 consecutive years, a feat he achieved in his US-based fund. He is also on course to beat the market for a 15th consecutive year. "Miller is classed as a 'value' manager, but not in the traditional sense as he judges value on the price he pays for a company relative to future potential (discounted) cash flows," Modray says.

Nick Greenwood, Iimia

HOME: Artemis Alpha

This investment trust is managed by John Dodd, a smaller companies specialist at Artemis.

In addition to shares, the fund can invest in other types of instruments such as hedge funds, derivatives, bonds and unquoted investments. If very negative on other types of assets, the manager would move the assets into cash to preserve investors' capital.

"At the moment, the fund has a strong bias toward oil exploration companies, a sector which we expect will continue to perform well given the high oil price and the fact larger companies like BP and Shell have under invested in this area," Greenwood says. The fund also holds a stake in the private equity of Artemis itself. Geographically, around 70 per cent of the portfolio is invested in the UK, with select investments in other regions. Greenwood warns: "This fund seeks high returns, but performance could be very volatile."

Shares of Artemis Alpha are trading on a premium of around 5 per cent to their net asset value.

AWAY: Morrant Wright Japan Income

Greenwood says that although the Japanese market has performed well in 2005, he expects this to continue throughout 2006 and the best qualified managers of investment trusts who can capture this trend are Ian Wright and Steve Morrant of the boutique fund management house Morrant Wright.

He says that although there have been many false dawns in the past, domestic recovery within Japan means this current recovery seems more entrenched. In particular, he likes the way the Morrant Wright Japan Income managers are aiming to take advantage of dividend growth in Japan.

"Currently, Japanese companies only distribute about a fifth of the income they earn, but that is set to increase as management becomes more shareholder friendly," Greenwood says. "That could attract more investors to Japan, which could further fuel growth in the market."

Gavin Haynes Whitechurch Securities

HOME: M&G UK Select

Haynes believes that after several years of outperfomance from smaller cap shares within the UK equity market, large blue chip shares will take the lead during 2006.

He says the manager of M&G UK Select, Mike Felton, tends to have a large cap bias within this fund, as well as a bias toward growth companies, which is another area that Haynes expects will come back into favour.

"Additionally, Felton has proven himself as a capable stock picker and he works alongside a strong team at M&G. Felton took over management of the fund early in 2005 after joining M&G from F&C, and since then it has been a very strong performer."

In his previous job Felton managed the Isis UK Prime fund (now F&C UK Prime) and that had exceptional performance. Haynes believes this strong performance can be replicated at M&G.

AWAY: Baillie Gifford Japan

After many false dawns, Haynes believes Japan and Europe are the areas are the key regions poised to outperform during 2006. He says that although there have been plenty of false starts or "dead cat bounces" in the past with Japan, there are signs that this current recovery is sustainable.

Included in that is the fact the Japanese economy has registered four consecutive years of growth. This has rarely happened since the end of the Second World War, he says.

Among funds best positioned to capture this recovery is Baillie Gifford Japan, managed by Hamish Dingwall. Haynes says Baillie Gifford has a large team of experts dedicated to investing in the Japanese market and performance, accordingly, has been strong. This fund invests across small, mid and large caps, so there is a broad and diversified exposure to the market.

Paul Ilott, Bates Investment Services

HOME: Rensburg UK Select Growth

Ilott says one problem facing the UK stock market next year is the relatively poor outlook for some of the dominant industrial sectors in the FTSE 100 index - banks, telecoms and healthcare. "Taking a balanced view of the UK market next year and looking to other sectors therefore seems to me to be a sensible step."

Furthermore, he says larger companies have performed strongly recently, but next year there's likely to be less of a gap between the performances of large, medium and smaller companies, "although larger growth oriented companies may still have the edge," he says. Ilott thinks having access to a highly flexible fund might therefore be one of the best ways to play the market.

Mark Hall manages Rensburg UK Select Growth with a very pragmatic, flexible style and selects stocks regardless of their size using the best ideas produced by the company's UK team, all of whom we rate very highly, Ilott says.

AWAY: Artemis European Growth

Ilott says the two regions he expects to outperform during 2006 are Japan and Europe, particularly due to the ongoing restructuring taking place at a company level.

Like Juliet Schooling, his first pick would be Japan, through Legg Mason Japan Equity. But Ilott says Artemis European Growth is also a good fund for 2006 as it should capture returns on the Continent, where earnings growth is currently at a 15-year high.

"In contrast to Japan, where the government is playing an important role in producing the right sort of environment for companies to restructure, in Europe it's the companies themselves that are setting the agenda," he says.

Ilott says Artemis European Growth, managed by Philip Wolstencroft and Peter Saacke, aims to identify individual restructuring stories at company level. "This is a fairly aggressively run fund for someone who is looking for exposure to mainly large and medium sized European companies," he says.