Each product has been given a star rating, representing its overall value for money based on cost, terms and conditions and investment potential.

Product of the month

The CF Octopus Opportunities Fund
This is Octopus’s first open-ended investment company (OEIC). It will aim to deliver capital growth by constructing a portfolio of investments in 30 to 50 UK smaller companies in the sub £100 million market cap sector. Stocks will be listed on AIM or the main London Stock Exchange. The fund manager believes the smaller companies sector is extremely inefficient, allowing specialist investors to identify significant opportunities.

The fund’s managers, Richard Power and David Crawford, already manage £120 million of AIM investments across Octopus’s VCT, EIS and IHT portfolios. They will be able to hold an unlimited amount of cash and will also have the ability to short relevant indices in difficult market conditions.

Minimum initial investment: £1,000
Initial charge: 5 per cent
Annual management charge: 1.5 per cent
Contact: visit www.octopusinvestments.com or call 020 7710 2800

Philip Johnson says:
The UK smaller companies sector can offer strong opportunities for investors because almost 70 per cent of all quoted companies have market values of less than £100 million. In spite of this, few fund managers focus on this end of the market. There is typically very little research available on these companies, which presents an opportunity for specialist smaller company fund managers like Octopus.

The smaller end of the market can provide the opportunity to invest in fast-growing companies at attractive valuations that have the potential to offer investors substantial upside growth. Over the past three- and five-year periods we have seen a strong performance from funds in the smaller companies sector, and this fund from Octopus is a welcome addition.

Funds in this sector are more volatile and therefore will not suit all investors. However, I like to include this type of fund within a more aggressive portfolio where the investors recognise that this must be a longer-term play.

The performance of Octopus’s model fund from December 2006 to May 2007 is very encouraging, significantly outperforming both the FTSE All Share and FTSE AIM All Share indices.

Quality usually comes at a price, and with this fund it is the charges that investors should be aware of. The initial charge is five per cent, with a management fee of 1.5 per cent and a performance fee of 20 per cent of annualised returns above LIBOR. From a positive standpoint, the performance fee should give the fund managers the incentive to earn it.

Although new to the market, the fund is well worth considering. Investors looking for more established funds in the smaller companies sector could consider those
from Marlborough and Old Mutual.

****

The GAM Star US All Cap Equity Fund and The GAM US Small & Mid Cap Equity Fund

GAM has launched two externally run funds investing in US stocks. The GAM Star US All Cap Equity Fund will achieve returns through a bottom-up research approach to investment within a global macroeconomic framework. It will employ an absolute return, deep-value approach. The focus will be on market survivors in cyclical industries, stocks with low price-to-book values and companies with a sustainable competitive advantage.

The GAM Star US Small & Mid Cap Equity Fund will target value-oriented companies in the Russell 2500 Value Index (a performance measure of small- to mid-cap US companies). The market capitalisation of investible companies will typically be between US$400 million (£200 million) and US$9 billion. The key to picking stocks for the fund will be a detailed analysis of the balance sheet and the business plan of any potential investment targets.

Minimum initial investment: £6,000
Initial charge: 5 per cent
Annual charge: 1.6 per cent
Contact: visit www.gam.com or call 020 7493 9990

Robin Amlôt says:
What should we make of the two new “stars” in the GAM firmament? Is now the right time to be considering investing in the US market, given the ructions and rumblings on Wall Street caused by the sub-prime lending debacle?

Both funds will be run in the US but not by GAM. The firm has already farmed out a clutch of funds and is, in fact, probably the fund management group with the biggest commitment to such outsourcing. GAM founder Gilbert de Botton subscribed to the not wholly unreasonable view that it is impossible to have all the best fund managers in-house. The corollary to that is, as a fund house, if you want to offer your investors access to the best talent, you have to outsource.

That sounds fine in theory and completely logical. Experience across the industry has, however, been mixed, and few groups have made a real success of the practice â“ indeed, many are no longer farming their funds out. Happily, GAM may be the exception to this. Giving fund managers a restrictive mandate leads them to do little more than track the relevant market index. GAM appears content to select the best managers and to let them get on with it.

In charge of the new US funds are two firms. GAM Star US All Cap Equity Fund is being run by Manning & Napier Advisors of Fairport, New York. Founded in 1970, it is employee owned and manages client assets worth more than US$15 billion. Manning & Napier will be looking to focus on well-positioned companies regardless of “growth” or “value” labels.

Chicago, Illinois-based Advisory Research will manage GAM Star US Small & Mid Cap Equity Fund. Advisory Research, founded in 1974, has US$6.3 billion in assets under management. The firm uses a value-based investment style to provide absolute and risk-adjusted returns.

GAM would appear to have chosen good management teams, so that brings me back to the question of whether you should be increasing your exposure to the US markets at all at this point in time. Wall Street is certainly underperforming relative to other markets, and anybody who has seen their dollar-based assets shrink as the dollar has fallen won’t be too happy about their experience “over there” so far this year.

But what of the future? Is the worst of the debt crunch past? Which direction will the dollar go next? You need to be sure of whose answer to these two questions you believe before looking at funds invested in this region.

***

Heartwood Pedigree Equity Income Fund
Heartwood Wealth Management originated as a division of solicitor Cripps Harries Hall and now provides integrated investment, tax and retirement planning solutions for high-net-worth individuals.

It says that traditional income fund analysis is on a total-return basis, assuming income is reinvested into the underlying portfolio. However, Heartwood has found that most of its income-seeking investors use this income to support themselves. Therefore, the fund manager has analysed the capital and income elements of the constituent funds separately to optimise their portfolio.

The fund can provide equity exposure within a diversified income model. It will meet the demand for regular and growing income products, but also aim to preserve capital in real terms. Key asset classes held will include bonds, commercial property and equities.

Minimum initial investment: £5,000
Initial charge: 5 per cent
Annual charge: 1.25 per cent
Contact: visit www.heartwoodwealth.com or call 020 7812 7030

Patrick Connolly says:
Many investors look to take income from their investment portfolios, and where they wish to take a higher level of ‘natural’ income there is not always a straightforward solution. By restricting underlying investments to only those that produce the required yield, there is a danger that the portfolio may not be adequately diversified.

Providing appropriate diversification, on the other hand, may not produce the required level of natural income, so investors may need to consider capital withdrawals. The latter approach does have the advantage that these withdrawals may be subject to capital gains tax (CGT), and many people do not use their annual CGT allowance.

Psychologically, investors may think there is more likelihood of protecting capital by taking a natural income, although this view is flawed. An investment portfolio will produce a given level of return made up of capital growth and yield, and the level of income taken will dictate whether or not the underlying capital remains intact. It therefore makes sense, before considering the yield, to get the asset allocation right. The most appropriate use of natural income portfolios is with regard to certain trust arrangements.

Heartwood claims to have a new approach to income fund analysis that looks at the capital and income performance of the funds separately. I am not sure what this will achieve as past performance is often unreliable, particularly as sentiment shifts and with fund managers moving around on a fairly regular basis. There is no method that guarantees results, and the only sensible approach is thorough analysis and the obtaining of exposure to a broad mix of assets in order to diversify risks.

With this in mind, it is prudent to include equity holdings with those from other asset classes. Heartwood does this principally with exposure to fixed interest and commercial property. This is the correct approach, along with other asset classes also being considered.

***

Henderson Diversified Income Ltd
This recently launched closed-ended fund from Henderson Global Investors will target an initial minimum yield of seven per cent by investing in a diversified portfolio of predominantly UK and European fixed-income assets.

Over the long term, the fund will aim to provide shareholders with a consistently high level of income and the prospect of capital growth. It will invest across the full spectrum of fixed-income assets.

The initial investment portfolio will be invested in secured loans (50 to 65 per cent), asset-backed securities (ten to 25 per cent), high-yield corporate bonds (ten to 25 per cent) and investment-grade bonds (up to 15 per cent). A small proportion of the portfolio will also be invested in derivative instruments.

Minimum initial investment: £2,000 (increments of £500)
Initial charge: n/a
Annual charge: 0.75 per cent
Contact: Contact your stockbroker for more information

James Davies says:
Generating a respectable yield in the current climate is not easy. On a risk-reward basis the argument in favour of fixed-interest assets has not been a strong one recently, with cash rates comparable to the yields available on most of the traditional investment-grade debt instruments, such as corporate bonds. At the time of writing, three-month LIBOR stands at six per cent. With current yields on most investment-grade corporate bond funds less than that, this makes it difficult to justify moving out of cash and into bonds.

It is against this backdrop that Henderson is seeking to expand its range of competently managed fixed-interest funds with this closed-ended, Jersey-registered/London-listed fund, which is being marketed as a “diversified” investment. Recent years have seen a proliferation of new ways for debt to be packaged and traded on the open market. I welcome it when quality managers are given licence to maximise their ability with the full range of weapons at their disposal. I consider the team selected to manage this fund to be a good one, with a strong track record in managing the Henderson Preference & Bond and Strategic Bond Funds.

What I am less convinced about is Henderson’s claim that this fund is “diversified”. It’s true that the fund incorporates some “alternative” fixed-interest asset classes. However, I would consider these to be sub-classes within the wider fixed-interest asset class. While this may seem pedantic, I take this view because I believe that, by and large, the assets will all be significantly affected by the same underlying forces within the credit market.

That said, the flexibility afforded to the managers, both in terms of type of investment and the fact that the fund can hold UK and European assets, makes it potentially more resilient to interest rate cycles and yield compression on one particular sector of the credit market (the fund can also invest a small amount in derivative instruments). The fact that more than 50 per cent of the fund will initially be invested in secured loans also makes it a slightly more cautious way to obtain the yield than investing in high-yield corporate bonds.

The closed-ended structure and Jersey-registered status may put some off, but equally, the high yield is likely to prove attractive enough to overcome this.

***

This article is from the September 2007 issue of What Investment.