How to invest in the UK for a stockmarket recovery

It wasn't just the weather that warmed up Blighty this summer - the UK stockmarket enjoyed its own heatwave too, with investors ploughing millions into shares off the back of a more upbeat outlook.

Cheered by a rebound in recession-hit UK, we've been hitting the shops with our cash again, as house prices and other economic pointers have started to improve.

Figures from fund management trade body, the Investment Management Association, show funds that invest in the UK stockmarket were the bestsellers in June 2013, where retail investors notched up sales of almost £480 million, the highest since October 2006. Sales fell to £398 million in July but were still well ahead of sales in the US, which amounted to £247 million.

Following a prolonged period of disappointing economic figures, the UK appears to be once again entering a stage of growth. Official numbers show the UK economy grew by 0.6% in the three months to the end of June, double the 0.3% achieved during the first three months of the year.

Stronger manufacturing, exports and job figures have meant many experts now think the outlook for the UK is better than they previously thought. For example, The Organisation for Economic Co-operation and Development has bumped its UK growth forecast this year to 1.5% from 0.8% and the National Institute of Economic & Social Research predicts the UK's economy will expand by 1.2% this year and by 1.8% in 2014, up from its earlier predictions of 0.9% and 1.5% respectively.

The higher forecasts are partly buoyed by a surge in optimism. According to research from consultancy GfK, consumer confidence in the UK is rising and in July hit its highest level in more than three years. And homeowners are once again feeling the comfort of property price rises. According to Halifax, in the three months to August, house prices were up 5.4% from a year earlier, the sharpest annual rise since the 6.3% clocked in June 2010.

As a result, it seems more of us are returning to the high streets and shopping malls to spend our cash, injecting millions into the economy. In fact, the latest numbers from the British Retail Consortium, the trade association for retailers, show that UK shops enjoyed their best July in seven years. Sales fell slightly in August but remained well ahead of the 12-month average.

Of course, while there are a variety of green shoots of hope arriving, investors must bear in mind that, despite the positive indicators, the UK still faces a long grind in getting back to a state of real and sustained economic growth, as it is still way off pre-crisis levels, when it would expand by around 3% a year. But, historically, stockmarkets tend to perform better when there is an anticipation of a better economic environment.

Patrick Connolly, a certified financial planner at Chase de Vere, says: "If the UK economy is on the road to recovery this will be positive for the stockmarket, although it is wise to recognise that what is happening elsewhere in the world is also hugely important."

Of course, there are two interlinking factors at play that will increase the appeal of stockmarket investing, namely low interest rates and rising inflation. With rates stuck at an all-time low of 0.5% and going nowhere, according to the Bank of England, until employment further improves, savers are struggling to find a savings account that will beat the rate of inflation - which eased slightly to 2.8% in July, from 2.9% in June.

But while there are potentially attractive gains to be made by dipping into the stockmarket, investors should remember that with the opportunity of better returns comes a greater risk of losing money. Here is a look at how best to invest for a UK recovery via diversified funds with strong track records.

UK growth funds

Rather than buying individual stocks, investors should look to lower and diversify their investment risk by opting to invest via a fund, sometimes referred to as a unit trust. When you invest in a fund, your cash is combined with that of other investors and used to purchase a spread of different shares by a fund manager. An active fund manager who invests in UK stocks, for example, will buy stocks they think will rise in value and avoid those they feel will fall.

There are myriad funds to choose from but Neil Shillito, managing director at independent financial planning firm SG Wealth Management, believes the AXA Framlington UK Select Opportunities fund, which among others has investments in fashion retailer Next and broadcaster ITV, is a solid starting point. Shillito says: "Its fund manager, Nigel Thomas, is of an outstanding pedigree and has been competently managing clients' money for many years." And over the past five years, it has delivered a return of 78% to its clients.

The £7 billion M&G Recovery portfolio, one of the largest and, at 44 years old, longest-standing funds in the UK, has posted growth of 51% over the same period. Key investments in the fund include oil giant BP and easyJet. Shillito says: "This is a good fund if you want to sleep easy at night, knowing the manager has a genuine care and alignment with his underlying investors."

For his part, Connolly tips the Investec UK Special Situations fund, which has achieved a return of 88% over five years. Connolly says: "Its manager Alastair Mundy is a long-term investor who focuses on buying cheap, out-of-favour stocks, holding them until they recover."

Peter Chadborn, financial planner at Plan Money, rates the Old Mutual UK Mid Cap fund as "a consistent performer", which over five years has achieved a sizeable return of 106% for its investors. For those seeking a more "passive" approach to investing in the UK, Connolly highlights the HSBC FTSE All Share Index. This portfolio simply mirrors the performance of the UK's FTSE All-Share Index. As the fund does not have a fund manager, it is a cheaper investment, costing about 0.2% per year, while the annual charge on an active fund will be nearer to 2%. However, if the market falls, so will your investment as there is no manager to navigate the fund. Over five years, it has achieved 49%.

UK Equity Income

Equity income funds, which aim to deliver income alongside capital growth, are highly popular among UK investors. Like growth funds, they invest across a wide range of companies but focus on investing in those which pay dividends - in other words, corporations that share their profits with investors. Typically dividend-paying companies tend to be large profitable firms. And dividends are big business; between April and June this year, UK firms paid out more than £25 billion in dividends to investors, the highest ever three-month total, according to research from Capita Registrars.

For investors seeking a UK Equity Income fund, Shillito recommends Standard Life Investments UK Equity Income Unconstrained. He says: "The fund has a very solid track record and a good team behind it and the yield is about 3.5%." Over five years, it has gone up by 63%.

Connolly likes Threadneedle UK Equity Income, which currently yields some 3.4%. Over the past five years, it has achieved growth of 73% and counts BT and insurer Legal & General among its main investments. He says: "This fund invests mainly in large UK companies and pays consistent dividends." The Schroder Income fund is one of Chadborn's primary UK Equity Income picks. The fund manager aims to identify "turnaround" companies, those with the potential to grow and better their business. The fund, which yields 3.71%, has achieved a considerable 86% gain over the past five years.

Take a global perspective

Mick Gilligan, head of research at brokerage Killik & Co, concurs there are encouraging signs of recovery coming out of the UK but notes the good weather no doubt helped retailers. In addition, many have pointed out that while the UK construction and housing sectors are doing well they are receiving a boost from the government's lending initiatives such as the Help to Buy scheme. As such, Gilligan recommends investors look at a more global portfolio with a bias towards the UK, so as to diversify their investments.

Gilligan points to two investment trusts, which operate like funds but differ in that they are listed on a stock exchange. He likes Caledonia Investments, which invests globally but has a strong leaning towards the UK, with some 54% of its investments there. The fund is slightly out of favour, returning 20% in the past five years but Gilligan believes the long-running portfolio has potential and its recent performance has been improving.

Gilligan also favours North Atlantic Smaller Companies, which is up 59% over five years. He says: "It mainly invests in the UK and US but is currently biased towards the former. It holds a number of companies in turnaround situations. Many of these are not highly dependent on UK economic recovery."

Patrick Connolly, meanwhile, tips the Aberdeen World Equity, up 48% over five years. It has just under 20% invested in UK companies but had exposure to other countries enjoying strong stockmarket gains including Japan and the US.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.