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Portfolio picking

12 July 2019

Ian Cowie explains how he chooses investment companies for his portfolio.

Investors enjoy a wide choice of different ways to seek income or growth or a mixture of both. Investment companies have a longer history than any other type of pooled fund in helping individual investors share the cost of professional asset management, aiming to minimise the risks of stock markets and maximise returns.

But, with 399 investment companies to choose from, such a wide choice can sometimes feel like too much of a good thing. Here’s how I have selected investment company shares for my personal portfolio over the last quarter century or so, which may help you - with or without professional advice - to identify companies to meet your individual needs.

Spread risk. Because share prices can fall without warning, it is important not to have too many eggs in too few baskets. So investors should always aim to diminish the danger of stock market shocks by holding a diversified range of investment companies in different commercial and geographical sectors, ideally with different investment objectives - such as the pursuit of income or capital growth or a mixture of both. That way, they shouldn’t all go up or down at the same time.

Consider consistency. Analysis stretching back more than a century shows that the longer you remain invested in shares, the more likely you are to obtain satisfactory results. That’s why it is often said you should only invest money in the stock market that you can afford to commit for five years or more. The Association of Investment Companies' (AIC) website page headed ‘Find and compare investment companies’ shows share price total returns for member investment companies over the last year, five years and 10 years. As a medium to long-term investor, I would always place more importance on the two longer periods.

Seek value. Short-term or one-year returns information can also be useful because it may indicate when a share or sector is out-of-favour or, alternatively, ‘flavour of the month’. The former may offer better value than the latter. Similarly, quality newspapers’ share price pages will show you the 52-week high and low for each share price, which can give an indication of whether buyers today are following fashion or, possibly, ahead of the herd.

Bag bargains. Most pooled funds charge investors a few percentage points more than their underlying assets are worth but most investment companies do not do so. Discounts - or the percentage by which most investment company share prices trade below their net asset value (NAV) - are also shown on the AIC website. These may indicate whether shares are expensive or might offer bargains for the brave. Discounts can widen as well as narrow and are no guarantee of value. Premiums - or premia - where shares trade above NAV, may be justified by above average income, growth of a mixture of both. Either way, your entry point - or the price you pay - is important to investment returns.

Look under the bonnet. Annual reports and fund managers’ fact sheets can also be seen on the AIC website and offer a wealth of important information for investors. This includes details of the underlying assets for each company - often under the heading ‘Top 10 holdings’ - enabling prospective investors to consider whether we agree with the fund manager’s stock selection.

Increasing income. Quality newspapers’ share price pages show the yield - or dividends paid to investors, expressed as a percentage of the current share price. The AIC website goes an important step further for income-seekers. The column headed “5yr dividend growth (%) p.a.” shows the annual rate of increase in income payments to shareholders over that period. No fewer than 20 investment companies have succeeded in increasing dividends every year for two decades or more - some have done so for more than 50 years. You can find all of them on the AIC website by searching for ‘dividend heroes’. No other form of pooled fund can show such consistently increasing income distributions.

These are the major factors I always take into account, along with reading the financial news every day, when selecting investment company shares. But many investors I admire would point to other factors, such as the length of time individual fund managers have been at the helm - this information is also available on the AIC website - or even the average price/earnings ratio or P/E of the shares in each company’s underlying portfolio, which is sometimes shown in annual reports and fact sheets. A low P/E might suggest a share is cheap, whereas a high P/E could indicate it is expensive.

Either way, a well-informed investor should make better decisions. The more you look, the more you will see.

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