3 ETFs for the Core of Your ISA Portfolio

ASK THE EXPERT: Building up seperate ISA investments over several years means you have reaped the tax benefits but may have a disjointed portfolio

Emma Wall 19 March, 2014 | 9:34AM
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Emma Wall: Hello and welcome to the Morningstar series, Ask the Expert. I'm Emma Wall and here with me today is Nick Hungerford, CEO of investment management company, Nutmeg.

Hello, Nick.

Nick Hungerford: Hello, Emma. Thanks for having me.

Wall: So we are here today to talk about ISA portfolios. This time of year people are looking to use up their ISA allocation, but also using that spring cleaning excuse to have a look at their existing portfolio. I thought we had start by talking about portfolio construction and why is it important and how do you do it?

Hungerford: You’re right about the spring clean approach. I mean lots of people find themselves looking at their ISAs and having a series of products. Each year they’ve bought a fund here and they’ve bought a fund there. And they say, well my 2009 ISA has done very well and my 2012 ISA hasn't done very well at all. But what we have got to try and encourage is for people to look at that portfolio as a whole, in the round. Is it, diversified? Is it, constructed properly? So I like this starting point. What can we do to give people a properly constructed portfolio?

The first thing I will suggest is that, we look at the asset allocation within the portfolio. So hopefully every year that people are buying a new fund or a couple of funds for the ISA allowance, they are not buying the same allocation and the same asset each time. So you are not buying another U.K. equity income fund every time. We have got to look to be spreading the risk between equities and bonds, commodities, gold if that's what's the form pick at the moment and other asset classes.

Wall: Not just asset diversification though, geographical diversification is important too, isn't it?

Hungerford: It's really important. I mean asset allocation and diversification make up about 90% of investment returns. That's really where it's important to make sure that you are getting it right. And sometimes people say, well had I been in cash; I’ve be missing an opportunity. Well equally a cash style asset could have been very productive in a downward market. So we have got to think about the asset allocation first and foremost.

Secondly, you go onto the sector allocations, the geographical allocations and they become very important as well. Just to give you an example, we have had a real focus on the emerging European economies at the moment. The recovering European economies and we have been allocating some money in our portfolios to Italian equities. And through the ETF selection that we have, we have used the iShare ETF for about 5%, which is quite a lot of the highest risk portfolios to allocate towards Italy. And that's been a strong driver of portfolio returns for the last couple of months.

Wall: I mean that allocation is probably what you would call a satellite holding, isn't it? You start by putting these core Steady Eddie holdings in the middle and then around that you can experiment with niche holdings in more risky sectors.

Hungerford: Yes. You are absolutely right. So we would always encourage someone to build from a solid platform of larger companies. So take for example, the Vanguard ETF for the FTSE 100 (VUKE), low cost, going to fulfill a lot of the portfolio. It gives you the U.K. exposure but it also gives you international exposure, because so many of those companies are earning their money, earning their dollars, earning their yen, overseas. So actually you get a real core holding in the middle there.

And then when you have got that fixed up and when you have got other asset classes in there maybe you want an iBoxx Corporate Bond fund (TCBT) as well to balance the equities, then you can look for the satellite holdings. And whether it's a sector pick or a country pick that's when you can get a bit more exciting.

Wall: And you mentioned two there, but looking at that core portfolio where people should be starting, what sort of funds, what sort of ETFs should people be looking for?

Hungerford: Well you have got to consider the costs of trading as well. So if you have got, £10,000 and you are doing one ISA and it's your first ISA and you are going to be using a platform, which is going to charge you to trade and then charge you to hold it. You probably want to be looking at something like the Vanguard FTSE 100 ETF. And make sure that you are investing in there and that's where your money goes.

Now if you can afford to expand a little bit more, if you say you have got three or four ISAs built up, so you are looking at £30,000 to £40,000, then why don't have a look at something like the Deutsche Bank European tracker fund (XMEU). Now Deutsche Bank, have recently launched this new range of tracker funds. They are extremely cost effective. This one is about 9 basis points. So you are getting charged 0.9% – sorry 0.09% for the holding. I mean it's an incredible price and that gives you exposure to a wide range of European stocks. So you can start putting into them.

We would also encourage people to have a look at U.K. smaller companies at the moment where we think there is great value. There haven't been priced at the same level of U.S. smaller companies. They haven't done as well over the last five years as the mid-sized companies in the U.K. So perhaps if you want three to start with; take a FTSE 100 ETF, then a tracker fund in Europe and a position in smaller companies in the U.K.

Wall: Nick, thank you very much. This is Emma Wall for Morningstar. Thank you for watching.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Emma Wall  is former Senior International Editor for Morningstar