At this time of year investors are bombarded with marketing material as the deadline for using up their ISA allowance on 5 April draws near. Inevitably they end up devouring past-performance tables, seduced by the massive gains that have been made as far back as the past decade, or as recently as the past year.
However, experts say that the way to build a better ISA is to look past these figures and at the assets and sectors you are investing in and, most importantly, your portfolio as a whole.
"If you’re building a portfolio, you don’t want to just select the best-performing funds in certain areas," Gleeson said.
"Firstly, you don’t know what’s going to be the best-performing fund over the next 20 years; you have no idea, you can’t predict the future."
"Secondly, it’s no good having three funds run by managers with similar styles and similar biases; they will all do well and badly together."
Gleeson says that he is happy to hold funds that perform relatively badly so long as they are spread across different sectors or regions, as this provides him with diversification benefits.
David Hambidge (pictured), head of multi-asset at Premier Asset Management, says that he uses this approach when picking funds for his multi-asset income portfolios.Hambidge has stuck with Bill Mott’s Psigma Income, a top-10 holding in his Premier Multi-Asset Distribution fund, despite its relatively poor performance in recent years.
"It’s investing in some of the mega cap underperformers that a lot of funds don’t buy," he said.
"Although it had a bad year last year it did very well in 2011 when the rest of the sector did badly, because of its bias to those defensive mega caps other people didn’t want."
Discrete calendar-year performance of fund vs sector
| Name | 2013 returns (%) |
2012 returns (%) | 2011 returns (%) | 2010 returns (%) | 2009 returns (%) |
|---|---|---|---|---|---|
| Psigma - Income | 8.62 | 6.85 | 3.64 | 9.8 | 20.51 |
| IMA UK Equity Income | 8.38 | 14.01 | -2.9 | 14.58 | 22.88 |
Source: FE Analytics
Data from FE Analytics shows that Psigma Income underperformed its sector in 2009, 2010 and 2012, yet was the seventh-best performer out of 92 funds in 2011.
Hambidge also holds Standard Life UK Equity High Income, which gives him exposure to a very different investment style. The fund performed relatively poorly in 2011.
"It gives me more exposure to the cyclical areas of the market," the manager added.
Bestinvest’s Jason Hollands agrees that this method of looking at your portfolio is the key to beating the crowd.
"The main mistake people make is they take each year as a free-standing investment decision," he said.
"They get to this time and realise there are six weeks to the end of the tax year and see analysts tipping Japan or whatever in the newspapers. They look at the performance tables and see XYZ topping the charts, so they buy it."
"They take each decision separately and don’t think about the overall strategy."
"This means they often buy the stuff that has just done well rather than thinking about where the future opportunity lies."
"Often it’s the markets that have had a tough time that rebound and do well again."
Hollands advises investors to start by thinking strategically: working out your objectives and tolerance to risk, before working out what proportion of your portfolio should be in each asset class.
It is critical, in Hollands’ view, to think about how any new funds you buy fit with what you already have.
"It’s really important you don’t just invest in what you hold already," he added.
According to Gleeson, one of the best ways to diversify your portfolio is to combine areas considered niche or risky.
This is because it is often these areas that are least correlated to the main markets and assets that investors allocate most of their money to.
Hollands points out that the correlation between major asset classes has risen in recent years as market movements have become dictated by policy decisions.
The process of globalisation has also increased the correlation between the major stock markets by putting more emphasis on trade between countries.
Data from FE Analytics shows that the FTSE All Share's correlation to the MSCI China index of Chinese stocks – 0.61 – is not so different to its correlation to the S&P 500 – 0.77.
However, it has an extremely low correlation to the MSCI Vietnam index – just 0.06 – meaning that a small exposure to the Asian country would do more to diversify an investor’s portfolio than a higher weighting to China.
Correlation of major indices
| Name | FTSE All Share |
MSCI China | MSCI Vietnam | S&P 500 |
|---|---|---|---|---|
| FTSE All Share | N/A | 0.61 | 0.06 | 0.77 |
| MSCI China | 0.61 | N/A | 0.28 | 0.54 |
| MSCI Vietnam |
0.06 | 0.28 | N/A | 0.23 |
| S&P 500 | 0.77 | 0.54 | 0.23 | N/A |
Source: FE Analytics
While this is not a strong argument for making a Vietnam fund a core holding, it is possible to select emerging market and global funds that focus on different, less-correlated regions.
Gleeson says this is likely to produce better returns at a lower risk than simply picking a handful of top-performing stories and will benefit investors with a longer time horizon the most.
The experts' check-list
- Look at where the manager invests (the information should be on the factsheet)
- Look at how the fund has performed in different time periods (the factsheet should show the fund’s returns and those of its benchmark in different years)
- Think through “what ifs? ” – do not bet your life savings on your predictions, you do not know what the future holds
- Don’t micro-manage: if you have followed steps one to three, there is no need to check how your investments are doing every month. You are in this for the long-term