Ask most investors with a reasonably long time horizon what they want from their portfolios and they will answer ‘growth’. More particularly, they want the value of their investments to rise to a degree that comfortably outpaces inflation.

For much of the past 25 years, this has been relatively easy. Yes, there have been some ups and downs, but, on the whole, the UK stock market has delivered an acceptable level of growth, and when it has been in the doldrums, other global stock markets have done the job. On the relatively rare occasions when equities have been in global retreat, property or even bonds have provided an inflation-beating alternative.

Winds of change
Now, however, investing does not seem so straightforward. Rising inflation, slowing growth and a financial hangover caused by too much cheap credit mean growth
is harder to find, so investors may have to move into unfamiliar territory to locate it.

Dan Kemp, fund manager at Saltus Partners LLP, argues that  ‘The first point is that growth investing has been deeply out of fashion for the past seven or eight years. So there are far fewer funds concentrating on growth around today, compared with the end of the last decade. Either growth funds have closed or they have been replaced by value managers.

‘That said, growth-style funds do tend to perform well during difficult periods, because growth companies have genuine pricing power so tend to come to the fore at such times. Also, valuations are far more attractive than they were when growth was last in vogue in the 1990s.’

What is growth?
It is important to understand where growth actually comes from. David Bulteel of private client stockbroker Rensburg Sheppards points out that ‘If you want growth, you still have to remember that the only time a shareholder gets anything out of a company is when it pays a dividend. So you need to look at where the dividend is going and whether it is growing or not.

‘People get caught up with the sentiment of it all, when they should be looking at fundamentals. For example, most portfolios are likely to underperform the UK index at the moment, because it is 30 per cent in oil and mining. We are seeing a bubble develop, which we are sure will not last, so we are moving to underweight the mining sector while we have just increased our weighting to defensive stocks and utilities.’

However, Martyn Ingram of investment research house IPM feels that growth investors have a lot to look forward to: ‘If you are focusing on growth, you are probably in a far stronger position at the moment than investors who need income. However, I think you have to look overseas, particularly to the emerging markets. Many of these have
decent growth prospects, whereas I don’t see particularly strong prospects in the developed markets in the near future.’

Mick Gilligan, director of fund research at Killik & Co, agrees that investors looking for above-average growth in the future will have to look to the emerging markets: ‘For growth, we would be looking overseas to a large extent. Investors should probably be looking at selective emerging markets, including the frontier markets, so something like the New Star Africa Fund would be worth playing for exposure to the sub-Saharan markets. Then there are the Middle Eastern markets, with options like the Qatar Fund, and Russia is also an area where we think we see good growth prospects.’

Focusing on fundamentals
Bulteel feels that ‘You can get too fixated with growth. You saw that with the TMT bubble, where people were concentrating solely on growth and forgetting real earnings. But if you concentrate on the fundamentals of a company, then growth will follow, so long as you get the fundamentals right.’

He explains, ‘There are two elements to this. One is the current earnings stream and the other is the management of risk. There are three things to look for here: the quality of management; the diversity of an investment at asset, sector and stock level; and, the most important element, time. There will be ups and downs, but if you have got the fundamentals right, companies will always move back to their long-term dividend trend at some point.’

However, there is no guarantee that history will repeat itself in terms of which sectors offer the best growth prospects. James Kinghorn, senior investment manager at Scottish Investment Trust, takes the healthcare sector as an example: ‘Traditionally, healthcare names have been a “safe haven” in times of weakening stock markets. However, the secular problems associated with large pharmaceutical companies, together with a US election, which always creates negative news flow as politicians target healthcare cost cuts, are likely to weigh on the industry.

‘We have focused our money in niche operators with strong product cycles and fewer competitive threats, such as Gilead Sciences, which produces drugs for the treatment of HIV, and CSL, which produces plasma products. Within equipment and services
we have Fresenius Medical Care, providing dialysis treatment and services.’

Different this time
Dan Kemp asserts, ‘Growth may be coming back into fashion, but it will be in different sectors from the IT, telecoms, media and technology stocks that dominated a decade ago. Now it is mining, energy and emerging market-related companies that are attracting investors, but these will probably prove just as cyclical as technology was last time round.’

Ingram adds, ‘I also wouldn’t go anywhere near financials, as I am sure there is more bad news to come, and I wouldn’t be too keen on property, either. These sectors will continue to suffer, as we have now gone from the credit crisis to the credit crunch.’

Managers of global investment portfolios are certainly keen to ride the momentum of the boom in commodity prices, particularly oil. James Kinghorn reports, ‘We have
a large position in the oil and gas industry, split between oil and gas producers and oil and gas equipment and services. The latter are benefiting from rising capital expenditure requirements of the producers, who need to drill more wells and are being forced to do it in more challenging locations.

‘This trend is likely to last many years, as oil demand will continue to rise given emerging market growth; and oil supply is constrained by limited new finds, and many years of underinvestment. As a result, we favour the drillers and hold Diamond Offshore, Noble Corp and Pride International; we also like equipment names National Oilwell Varco and FMC Technologies. Among the producers, we like companies that will be able to generate many years of production growth and have holdings in Suncor Energy, EnCana, Petrobras, and BG Group.’

Attractive utilities
Another core theme for many global fund managers is the utility sector, particularly companies involved in the provision of energy and water. Mark Urquhart, manager of the portfolio for the Edinburgh Worldwide investment  trust, points out that ‘Due to the economic growth of nations such as China and India, it is anticipated that energy stocks will continue to perform well through the economic downturn that many Western economies are experiencing.

‘However, some energy companies will perform better than others. Two that may outperform their peers are Petrobras and Gazprom. Although classified as “emerging market” stocks by virtue of location, they are two of the largest companies in the world; both have greater proven reserves and lower extraction costs than the traditional energy majors.’

Andrew Whalley, manager of Premier Energy & Water, an investment company that specialises in these sectors, adds, ‘Because the energy and water sectors are essential services, they tend to be less economically sensitive than most other industries.

‘In addition to their defensive characteristics, these sectors are seeing rising demand, notably in developing countries such as China, India, Thailand and Malaysia, and we believe growth here is likely to outstrip GDP for many years. In particular, demand for carbon-free energy will dominate new-build, so the renewable energy sector will continue to experience growth.’

But Whalley also points out that this is not solely an emerging market theme: ‘It is not only emerging economies that will provide opportunities. In Western economies, new-build, particularly in energy, has been sub-optimal over the past decade.

However, new technologies, such as carbon capture, tidal stream and wave power, allied to significant new-build of established plant such as nuclear, coal, wind and gas, will provide exciting new investment opportunities.

‘For example, my fund has recently announced it will focus on the energy and water sectors in both emerging and established technologies and countries, and we believe that, despite the current market turmoil, the outlook in these sectors has rarely provided us with better opportunities.’

Infrastructural opportunities
Another key global growth theme is spending on infrastructural development. Neil Hermon, manager of the Henderson Smaller Companies investment trust, says, ‘In uncertain times, investors will pay up for companies that display earnings resilience, and I believe companies that build and provide services to the infrastructure market have this resilience.’

This theme plays out just as strongly at home as in the emerging economies. Hermon notes, ‘The UK government has made a commitment to areas such as education, transport and health that will require the investment of tens of billions of pounds. The 2012 Olympics will also provide a short-term boost to demand. Businesses that provide services to these areas are poised to do well.

‘Of particular interest are companies such as Balfour Beatty, Carillion and Interserve, which all have strong balance sheets and long and secure order books; they are set to grow steadily over the medium term and currently sit on inexpensive valuations. They are all poised to do well.’

Back to basics
Saltus Partners’ Dan Kemp feels that ‘It is important to look at individual stocks. If you are investing in a fund, you need one run by a genuine growth manager with a reasonable spread. I would  not go into specialist funds, like energy, but the problem is that there aren’t many of these growth managers about and most of them are running specialist funds! But if I had to suggest three good growth-orientated funds, I would plump for Aegon UK Opportunities, Threadneedle American and Baring European Growth.’

Bulteel concludes, ‘With rising inflation, you want to invest in things with a secure dividend stream. Don’t try to be too clever. Stick to basic principles of quality, diversification and time, and you won’t go too far wrong.’