Looking for investment portfolio growth, against the trend in property and global markets? HIGH RISK but diversified and actively managed, specialised portfolios could be the answer. Ideal for part of any pension or investment portfolio

Turbulence in the equity and property markets over the last year has reaffirmed that reliance on one or two assets or methods of investing will eventually bring disappointment.

One reaction has been for investment advisers and banks to guide clients to cautious/conservative multi asset fund management - we have done some of this ourselves. Whilst this might suit a cautious/balanced investor by mainstream thinking and FSA guidance (that’s the government!), we argue that a client who categorises themselves as high risk and builds a range of different assets wider than mainstream government regulated funds, may well be much better off in the longer term.

An alternative proposal to regulated portfolio or fund management where daily access is available, is to spread any capital between the ideas illustrated below, diversifying risk into assets which do not necessarily move with the main markets. These include Investment Trusts, Structured Products, Alternative Assets, Hedge Funds and Commodities.

The following conceptual proposition would be for high risk investors with approximately £100,000 plus to invest for 5 years plus.

Investment Trusts

Investment Trusts might be considered as more effective vehicles to access the investment world than Unit Trusts, OIECS and Insurance Company funds because

• they raise a fixed amount of funds to invest, not suffering from excessive in or outflows of money
• their ability to borrow money can enhance returns and increase risk
• of their flexibility to hold large amounts of cash when deemed prudent
• their managers tend to remain in place much longer than Unit Trust managers
• of the possibility to buy investment trusts at a discount to their net asset value

Example of an Environmental Markets Investment Trust

This invests in companies making a positive impact on the environment, investing approximately :- 1/3 in energy stocks, such as wind power and solar panel technology, 1/3 into the water sector 1/3 into waste management and other environmentally sensitive stocks

The trust has had a good long-term record and should continue to benefit from the increasing interest in climate change.

Structured Products

These provide investors with exposure to stock markets with a degree of downside protection. Those that have been in existence for some time, launched when the market was considerably lower than it is today, have the potential to give positive returns even if markets fall from their current level. Structured products have a fixed life and generally pay out no income. They are traded on a daily basis to avoid being “locked in” for the life of the investment.

The main risk is if the banks where the money has been deposited over the life of the product were to go bust. If that were to happen we would have far more serious things to worry about than these particular investments!

An advantage is that they strip out the movement in the currency so that returns depend purely on the underlying index and not movements in the currency, further reducing the risk in overseas investment.

Example showing steady growth in a falling stock market

These shares have a life of between one and four years. The position is reviewed on February 6 each year. Launch level was 5875.40. Shares pay out 11p per annum providing the index has not dropped by 10% per annum. Current price is 99.25p giving returns as follows:-

• On 6 February 2009 FTSE 100 is at or above 5287.86 return is 111p
• On 8 February 2010 FTSE 100 is at or above 4700.32 return is 122p
• On 7 February 2011 FTSE 100 is at or above 4112.78 return is 133p
• On 9 February 2012 FTSE 100 is at or above 3525.24 return is 144p

If the market does not fall by 10% per annum in four years, investors should receive growth of 11% per annum. Only if the market were to fall by more than 50% from its launch date to a level of 2937, will investors’ capital be at risk since, if the market does dip below this point in the next four years and does not recover, then losses will be on the basis of one for one on the downside.

This gives the opportunity of a positive return even if the market falls for the next few years. The market already appears to be discounting a lot of bad news and may begin to recover, in which case 111p will be received in a year’s time. This would be a reasonable return compared with returns on cash and compares favorably with the yield on gilts.

Alternative Assets

These are invested in areas that do not necessarily move in line with equity markets.

Example of an Infrastructure Investment Trust

This should be able to pay secure and above average level of income which could also keep pace with inflation. This vehicle is invested in a portfolio of relatively mature public finance initiative projects, where the government is paying out a regular stream of income to maintain public buildings. The trust manages these contracts and uses its size to negotiate better terms. It is scheduled to pay out a dividend yield of around 5.0%. Since these contracts are government guaranteed and relatively long-term, this level of income is attractive compared to returns over long cash deposits and government gilts.

Hedge Funds

Previously a combination of tax and regulation made it very difficult for all but the most wealthy to buy into this asset class. There are now a number of good quality fund of funds available to the private client on the stock market.

Hedge funds pay out little/no income and are included in the portfolio to provide long-term capital growth and further diversification, reducing the overall dependence on strong stock market performance.

An example of a Debt Strategy Hedge Fund

This fund has built up an enviable record through dealing in distressed debt securities in America. The fund has been going for 120 months and has produced gains in all but six of these monthly periods. This growth has been achieved despite differing conditions in equity and fixed interest markets.

Commodities

It has always been possible to invest into gold and base metals indirectly through mining companies, but mining shares tend to move more in line with sentiment in equity markets than in accordance with the price of the underlying commodity. In the last few years it has become possible for private clients to invest in funds whose performance is directly linked to commodity prices, with the additional advantage that these funds are structured to give enhanced performance on the upside and capital protection on the downside.

Example of Oil & Base Metal Prices

This structured product offers 230% of the upside of a portfolio of commodities. The product has a six year life to March 2012 with a minimum redemption value of 100p per share. The shares offer a way of participating in the rise of commodity prices that is not dependant upon the performance of stock market investments, with capital protection of 100p per share. At the current price of 118p the risk/reward ratio looks attractive. This product provides good diversification from the equity market since the outcome is dependant on commodity prices rather than sentiment in the stock market.

Conclusion

By spreading the portfolio between different alternative or specialised assets, the dependence of the portfolio on the performance of equity markets alone is considerably reduced. This significantly reduces the overall element of risk. The portfolio has a considerable degree of diversity, while gaining exposure to the higher risk element of the global markets.

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Over the long term, investment in stocks and shares has provided a better total return than bank or building society accounts or fixed interest stocks. However, the value of shares and the level of dividends can fall as well as rise; investment in shares should therefore be regarded as a long term commitment, which is for at least five years. Any references to taxation are based on our interpretation of current tax levels and relief in the UK which may be subject to change. The value of any tax relief will be dependent on individual circumstances.