Bonds or shares: the dilemma as confidence returns to funds

With billions being invested in funds, we asked the experts where to go for returns

Confidence finally appears to be returning to the investment world with billions of pounds being ploughed into funds over the past couple of months.

More than £2bn was invested during June to bring the total assets under management to £488bn, according to the Investment Management Association. This helped to push net retail sales for the first half of the year up to £10.8bn – the second best on record – with fund groups hoping such inflows will continue.

But where is all the money going? Is it being tucked away in so-called safer funds or are investors being more adventurous and channelling it into equities? An analysis of the data reveals a pretty even split between equities and bonds, with both having enjoyed net retail sales of more than £500m. However, the less risky sectors do seem to have attracted the lion's share of funds.

The best-selling sector was Cautious Managed (£218m) which took over from Absolute Returns. It is actually the second time this year the sector has taken top spot and it has been in the top five sellers for five months out of six.

At the other end of the table, Japanese Smaller Companies suffered outflows of £114m, Europe excluding UK shed £98m, Japan lost £31m, and UK Equity Income & Bond Income was down £10m. But are these investors right? Does playing it safe make sense now with all the economic uncertainty, or should they be putting the money into racier assets? Are shares still looking attractive – or are they only cheap for a reason?

We asked financial advisers, fund groups and commentators what sectors they favoured for two distinct scenarios: maximising returns over the coming year and generating the best returns with an investment horizon of at least five years.

Caroline Hitch, HSBC Global Asset Management

Interest rates in developed regions are likely to remain low for the rest of this year but although this is good news for investors there are potential risks, warns Hitch, senior portfolio manager at HSBC Global Asset Management. "Data suggests the US economy is faltering and the chairman of the US Federal Reserve, Ben Bernanke, commented that the economic outlook is 'unusually uncertain'," she says.

So how should investors respond? "Our recommendation is to have a diversified portfolio that is appropriate for that investor both in terms of their risk appetite and capacity to absorb that level of risk," she explains. "They can then tilt their portfolios to take advantage of shorter-term outlooks."

At present her favoured tilts are a preference for defensive sector equities, such as utilities, as they are attractively valued and typically offer higher dividend yields. "We also prefer corporate bonds as the yield on these is higher than their government counterparts and many companies are still engaged in strengthening their balance sheets, which is positive for bond investors."

Justin Modray, Candid Money

The founder of the website Candid Money believes the UK Equity Income sector could offset possible market falls over the next year, and highlights Newton Higher Income, Schroder Income Maximiser and Invesco Perpetual High Income.

"I'm fairly pessimistic about the outlook for the next year as there's a good chance the UK and others could fall back into recession as spending cuts and tax rises take their toll," he explains. "If economies and stock markets do struggle then high-quality government debt and corporate bonds could benefit as investors flock to safety."

For those looking to invest for at least five years he suggests commodities and emerging markets are worth a look, particularly the First State Global Resources and Blackrock Gold & General funds.

Darius McDermott, Chelsea Financial Services

There are such mixed messages coming out of the markets that many fund managers are split at the moment, points out Darius McDermott, managing director of Chelsea Financial Services, and this is making life pretty difficult. "One theme which could be a good bet for the next 12 months is agriculture or commodities with food price inflation kicking in," he says, suggesting the CF Eclectica Agriculture fund and the Sarasin AgriSar fund are worth considering.

Longer-term investors, meanwhile, should still be looking at emerging markets. "They have had a very good run but people need to have a growing allocation to this area," he adds. "We like First State Asia Pacific Leaders, Ignis HEXAM Global Emerging Markets and Allianz BRIC Stars fund, which invests in the four biggest emerging markets."

Mark Dampier, Hargreaves Lansdown

The head of investments at Hargreaves Lansdown suggests looking at corporate bonds over the shorter term. "We are going to have a prolonged period of low interest rates and, when you consider the gilt market has rallied very strongly, then corporate bonds look pretty good value," he says. "I like the Invesco Perpetual Monthly Income Plus, where you also get exposure to Neil Woodford's equity income approach. This yields 7.5%, which looks particularly good with interest rates at 0.5% and gilts at 3%."

Emerging markets look fine for longer-term investors, with Russia and Japan offering good opportunities. "Japan often gets forgotten about, but some of the shares in this country are just so cheap. I'm not saying the economy looks good, but the market is certainly not expensive. I like Invesco Perpetual Japan, while the Neptune Japan Opportunities is fully hedged against the yen falling which should eventually happen."

Andy Gadd, Lighthouse Group

Trying to maximise returns over a year means it is also important to limit potential losses as well, says Gadd, head of research at Lighthouse Group, who suggests the Absolute Return sector, given the current market uncertainties.

"These funds are a potentially rewarding investment when markets are volatile and investors are nervous," he says. "However, investors need to appreciate that they are all likely to underperform in a bull market." As far as recommendations are concerned he highlights William Littlewood's Artemis Strategic Assets Fund.

Over five years he likes the UK Equity Income Sector, and suggests the Neptune Income fund is worth a look. "Funds in this area aim to provide investors with a growing income as well as the potential for long-term capital growth," he explains. "They also invest in mature 'value' companies that are able to pay a healthy dividend and potentially weather downturns better than growth-oriented alternatives."

Patrick Connolly, AWD Chase de Vere

The head of communications at AWD Chase de Vere also likes corporate bonds, although he is anxious to emphasise this will not be the best-performing sector if stock markets suddenly take off.

"Volatile stock markets have shown us the value of asset allocation," he says. "While some investments are falling others need to hold their value, and this is an important role that fixed interest funds perform." M&G Corporate Bond and the Fidelity Moneybuilder Income fund are his recommendations.

Over the longer term he likes UK Equity Income names with Artemis Income and PSigma Income high up on his list. "Traditional equity income shares were left behind during the stock market rally in 2009 and still represent comparatively good value now. These are often large secure companies that are making profits and producing dividends and so are well placed to cope with any difficult times ahead."

'We could yet see the Japanese stock market perform'

Investors are taking their cash out of Japan, according to the IMA statistics, but are they right, or does poor recent performance mean it's time to revisit the country?

"Japan is often unloved by investors as positive returns have been hard to come by over the last 25 years," points out Adrian Lowcock, senior investment adviser at Bestinvest. "The situation in the country remains just as unclear today," he adds, pointing towards an ageing population, unsustainable demographics and a political system which protects its own interests.

"These are well-known long-term issues, but the short-term issues are likely to affect performance of the stock market," Lowcock says.

"Japan is a large exporter and therefore any signs of weakness in the global recovery and concerns over entering a double-dip recession will affect Japan more than other countries. In addition, the currency is strong at the moment, which is affecting growth."

But that doesn't mean you should avoid Japan, he says. "On an historic basis the Japanese stock market continues to look extremely cheap (close to a 40-year low) and there are plenty of companies with dividend yields over 10 per cent. The country is full of world-class companies well-placed to benefit from the economic growth, particularly in technology."

He recommends having some exposure in Japan, around 6 per cent. "If fears of double-dip recession fade and Asia roars, then we could see the Japanese stock market perform."