In this article from The IRS Report in June 2009, Chris Gilchrist talks about collective funds.……

Aim for big profits with small speculations

I have little confidence in my ability to predict the short-term movement of markets. Treasury ministers and central bankers are all at sea, unsure of whether or how their unprecedented reflationary measures will work. The economic outlook remains uncertain. World stockmarkets could take another nasty dip. Or it could be sunshine all round.

Right now, your portfolio may contain a pile of cash, as mine does, and you may feel it is too early to be adding a lot to your equity exposure but worry about missing the boat when the market turns. One strategy for such uncertainty is to keep most of the cash on deposit but to place small upside bets on a range of - hopefully - uncoordinated assets woth lots of upside potential. You can think of this as a variation of the "core and satellite" portfolio approach, where your core is long-term buy-and-hold and your satellite is sex-and-violence.

My approach is to seek bombed-out sectors of world equity markets and place small bets using collective funds. There is a lot of risk involved, which is why the bets need to be small - no more than 2% or 3% of your portfolio, I suggest. Each of the sectors is risky in itself, and on top of that I cannot ignore the recent history: chances are that if there is another twist in the bear's tail all these risky assets will tank together, at least temporarily.

Sectors I have been watching include Japan, especially small-cap stocks; private equity; Russia; India; biotechnology; European small-cap; real estate investment trusts (REITs); and gold mining shares.

Many sectors that have crashed over the past few years have seen sizeable recoveries in the past six months. In principle I do not let this put me off, but the euphoric market response to the Indian election results leaves this market obviously susceptible to a shakeout. I believe India is a better prospect than China, but having already got a small position, will follow Deborah Owen's advice and wait to add more until prices track back a bit. Likewise, Russia has had a strong recovery on the basis of gains in oil and mineral prices. I suspect a strong speculative element in these markets - with the world full of tankers brimming with oil and China bragging about rebuilding its resource stockpiles, the odds of a setback in the commodity markets seem high, and I'm content to wait for a better buying opportunity, when Neptune Russia and Greater Russia unit trust and J P Morgan Russian Securities Investment Trust (JRS) will be my preferred vehicles.

I referred to biotech's surprisingly good performance in our last issue. Again, this is a strong ongoing story, but it hasn't had a crash and looks likely to take off only when a real bull market is under way. I am more interested in sectors that look to have scope to motor regardless of the market trend.

REITs have obvious recovery potential, and since European markets have taken such a hammering, even the recent 25% upturn leaves the index at 40% below its high two years ago. There is a suitable exchange Traded Fund (ETF) for this sector, i-shares FTSE/EPRA European Property Index (IPRP). Given that conventional collective funds face transaction costs of about 5%, which are built into valuations, this is an area where an index-tracking ETF really does offer a significant advantage.

Small-capitalisation shares have taken a beating in all major markets, but Europe and Japan are special cases. In both markets, small companies are a more dynamic part of the economy relative to their large-cap peers than is the case in the US or UK, whose economies are more open and competitive. As a business, you have to be pretty good to succeed when the odds are so heavily stacked in favour of the old incumbents as they are in most of socialised Europe and corporatist Japan.

There are indices tracked by ETFs for both sectors, but in small-cap markets I believe stock selection can add a lot of value relative to an index. So I prefer to play the Japan story with the JP Morgan Fleming Japanese Smaller Companies Investment Trust (JPS). Managed by David Mitchison, it has done a little better than its peer group over most of the past three years and traded at a 10% discount to Net Asset Value. I was encouraged to note that James Montier, the "deep value" strategist, recently reported that his value screens threw up more Japanese small companies as outstanding value buys than any other category of stock. Every dog has its day, and this one's day has been a long time coming - the 5-year chart of this asset class is truly grim.

European small-caps, in contrast, had a great bull market. European institutions had overlooked the sector, giving active fund managers a great opportunity to make hay before the 2008 crash. Over the past six months, the sector has made a 30% recovery, but offers better value than large-caps and is still over a third below its 2007 high. Again, there are ETFs that track indices but I likeThreadneedle European Smaller Companies, a unit trust that did well in the bull run and should do so again.

The most bombed-out sector of all on my watchlist is private equity, which used to be called venture capital before that name was appropriated by Venture Capital Trusts. Large listed private equity groups hold a set of investments ranging from start-ups through buy-outs and taken-private PLCs. It's the last category that's responsible for the massive discounts to NAV at which many of these stocks now trade - an eye-watering 50% in some cases. Many of the hugely-leveraged deals undertaken in 2005-07 are likely to fall apart, rollover funding may not be available from banks or if so only at higher rates, and on top of this the valuation of unquoted investments is always a dodgy issue for such funds in a bear market. Does the value at which an investment is carried in the books bear any relation to its real worth? The only real test is a market transaction, but there aren't enough of those to underpin valuations. All that fear is in the price.

I have not dug into the specifics of the smaller listed private equity investment companies in London, nor the VCTs. I am sceptical about my ability to come tothe right conclusions on the basis of publicly available information. So here I do prefer the ETF. The 1-shares Listed Private Equity (IPRV) tracks the S&P Listed Private Equity Index, which contains 25 of the world's largest private equity funds, with 37% in the US, 23% in Europe, 19% in the UK and 17% in Japan. I am sure it's possible to make more money out of some of the London-listed investment companies, and if you have, say, £10,000 or more to invest in this asset class it would probably be worth doing the research and buying five LSE-listed stocks. I will stick with the ETF.

Finally, while chartists remain sceptical about the gold bullion price trend, it does look as if the valuation basis of gold mining shares is changing. A few months ago gold mining shares were at their lowest level relative to bullion for over two decades, but have since outpaced the rise in bullion. Recent gains have been a bit too rich for and again, I suspect a big speculative element in this rally, so will wait to add to my holding in the Blackrock Gold and General unit trust.

I recently purchased JP Morgan Fleming Japan Smaller Companies and i-shares Listed Private Equity. I expect to buy the i-shares European REIT ETF and Threadneedle European Smaller Companies in coming weeks.

You can see all of Chris Gilchrist’s articles at www.TheIRSReport.com.

Chris is the editor of The IRS Report every month.

Call 0800 756 5437 or click here for more information.