The prospect of a new British ISA has put the spotlight on the UK market. Some investors will not feel comfortable picking individual shares and an alternative is to look at actively managed funds and investment trusts. Here are some tips on putting together a UK-focused portfolio. 

WHICH FUNDS AND TRUSTS WILL QUALIFY FOR INCLUSION IN THE BRITISH ISA? 

The rules for which investments can qualify for inclusion in the British ISA have yet to be agreed. The consultation document says one option to consider is allowing funds and trusts that have at least 75% of the value of their investments in eligible UK companies. 

By ‘eligible’ it would be fair to assume these mean UK-listed stocks, namely those trading on the London Stock Exchange (Main Market and AIM) and Aquis Stock Exchange. 

The Investment Association and The Association of Investment Companies both require 80% minimum exposure to quoted UK shares to qualify for their ‘UK All Companies’ sectors. 

That immediately creates a scenario which is at loggerheads with what the Government is trying to achieve. It wants to use the British ISA to support companies in the UK and help them grow, yet allowing a fund or trust in the investment wrapper that can have up to 20% of its assets in foreign companies such as Microsoft (MSFT:NASDAQ) or Amazon (AMZN:NASDAQ) defeats the purpose. 

There is also the issue that many companies on the UK stock market earn some or all of their earnings in a foreign country. This might not trouble certain investors as global diversification can be a positive thing when investing. It just means that the government will have to decide if the British ISA is a vehicle to support the UK economy or, more realistically, a vehicle to stir up more interest in the UK stock market. 

DIFFERENT FLAVOURS OF FUNDS AND TRUSTS 

Funds and trusts that invest in UK-listed stocks typically follow one of three investment styles and sometimes they blend them together. 

Managers typically have a value, growth or income bias. Value investing means looking for stocks trading below what they think a company is really worth. Growth investing means finding companies which are growing earnings at a decent rate. Income investing is about picking stocks that can deliver a stream of dividends. 

Sometimes a fund manager will look for both value and growth, meaning they want to pick companies whose valuation is fair or cheap and capable of delivering good earnings growth. 

A lot of companies in an income fund might be cheap because generous dividends are often found with mature companies which have pedestrian growth rates and which trade on cheap valuations. 

In addition to style, a fund or trust may restrict their search for opportunities based on a company’s size. Funds or trusts in the ‘UK All Companies’ space can look for any size business, but they will typically concentrate on larger ones. Some funds and trusts specialise in mid-caps which simply means they pick stocks from the FTSE 250 index; others look at smaller companies. 

WHICH ONES TO PUT IN A BRITISH ISA? 

Investors should consider what is already in their portfolios and whether adding UK-focused investments either to an existing ISA or SIPP, or to a British ISA once launched, will add a new dynamic or not. 

For example, someone with a global tracker fund might add a UK smaller company fund if they share the view that small caps have been unloved for several years and could bounce back once interest rates start to be cut. Another person looking for income-generating investments might explore opportunities with a UK fund because yields are often greater than you find in other parts of the world and valuations cheaper. 

THREE UK-FOCUSED FUNDS AND TRUSTS THAT STAND OUT FROM THE CROWD 

Past performance is not a guide to future performance but looking back over history can help to spot funds or trusts that have demonstrated stamina and prowess. It is important to look over a long period such as 10 years to separate those which have skills versus those which might have just got lucky over the short term. 

Each of the following funds and trusts outperformed the FTSE All-Share index of UK companies over a three, five and 10-year basis and have qualities which make them stand out from the crowd. 

WHERE TO START? 

First-time investors or those with little experience should start with funds because they provide diversification which means you are spreading your risks. 

Imagine having a portfolio of three stocks and one of them went through a bad time – it could really damage your overall returns. Having a handful of funds means you should get exposure to a much large number of companies or other assets sitting in the underlying portfolios. If something goes wrong with a holding in one of the funds, you will have a lot of other stuff to act as a support and minimise the pain. 

Investment trusts also provide diversification but they can be a bit more complicated to understand. That is because they can trade above or below the value of the underlying assets. 

Discounts and premiums to NAV (net asset value) can sound like gobbledygook to someone who does not really understand investing and that is certainly not ideal for someone who has never done it before. That is something to bear in mind if looking to put money into the British ISA, or indeed any type of ISA or self-invested personal pension (SIPP). 

BACKING COMPANIES THAT DO GOOD: 

ROYAL LONDON SUSTAINABLE LEADERS (B7SGTR8)

This fund might suit someone with strong views about the type of companies they do and do not want to invest in. It focuses on companies that have a net positive benefit on society via their products and services or in the way they do business. What you do not get is exposure to activities such as nuclear power, weapons manufacturing or animal testing for non-medical purposes. Some of the key holdings include AstraZeneca (AZN), London Stock Exchange (LSEG) and Compass (CPG). 

BEST IDEAS FROM THE FTSE 350: 

ARTEMIS UK SELECT (B2PLJG0)

Think of this as a ‘best ideas’ of the FTSE 350, with about three quarters of the fund held in large UK companies and the majority of the rest in medium-sized businesses. The manager has a simple premise: find companies that could get a lot bigger over time and then whittle down the selection based on a corporate’s health and prospects. The portfolio includes quite a few banks and oil companies like Barclays (BARC) and Shell (SHEL), while the industrials sector is also a favourite with the manager. The fund can bet against companies it thinks will struggle on the stock market through a process called ‘shorting’. 

A GROWING STREAM OF INCOME: 

LAW DEBENTURE (LWDB)

This is an investment trust with a twist. In addition to running a portfolio of UK stocks, Law Debenture also provides services to corporate trusts and pension trustees. This provides an added diversification that ensures the performance is not solely reliant on the direction of the stock market and an important revenue stream that supports the payment of a higher dividend without constraining the manager to focus exclusively on higher-yielding stocks. The 4% dividend yield is less than top-paying cash accounts at present but savings rates are expected to trend lower this year if the Bank of England cuts the base rate. In comparison, Law Debenture looks for consistent income growth and has achieved 7.9% compound annual growth in its dividend over the past 10 years. 

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