Three wealth-creating funds

Professional investor Simon James believes we should be looking to buy companies with wealth-building characteristics – such as strong balance sheets, excess cash flow, and a good and growing dividend. Here, he picks three funds that aim to do just that.

Each week, a professional investor tells MoneyWeek where he'd put his money now. This week: Simon James, founding partner at Gore Browne Investment Management.

The coalition government's approach to tax will reinforce Britain's dependence upon corporate investment and development during the next decade. The economy will behave very differently in the years ahead compared to what we've been used to. The 'buy now, pay later' creed can no longer be sustained. Tight credit, higher personal taxes and job insecurity should drive debt repayment and higher savings, which will constrain consumption.

We now need a new drive towards wealth-creation and away from indebtedness. How can we do this? By encouraging people to work, creating new businesses and employing others; by encouraging net domestic saving and investment in productive rather than passive assets; by encouraging inward investment into the UK; and, finally, by not confiscating savings. The shift in the balance of taxes in the Budget makes an encouraging first foray in this direction.

The ideas are simple. To encourage people to work, raise personal allowances before cutting top tax rates as this reduces disincentives at the low end of earnings. Then gradually raise the pension age many people are willing and able to work for longer. To create jobs, cut corporation taxes, especially for smaller firms, and progressively cut the tax on employing people to zero by eliminating employers' national insurance. And encourage multinationals to remain or establish themselves in the UK by offering a sympathetic tax regime.

Saving should also be encouraged by ending the distinctions between different savings vehicles and simplifying their tax treatment. And most important, we should emphasise investment in wealth-creation rather than stores of value for instance by encouraging investment in business capital and infrastructure rather than property or cash. To finance such wealth-oriented reform, taxes should be raised in areas of discretionary spending (VAT), and upon local resource usage (green taxes, property and toll roads). Broadly, this is the balance of the Budget.

So, investors should look to buy companies with wealth-building characteristics such as strong balance sheets, excess cash flow, and a good and growing dividend. At one end of the spectrum, there are the large multinationals with global brands and exposure to emerging markets. With interest rates low, and the outlook for gilts tough, income investors should look for dividends. UK multinationals with strong balance sheets, excess cash flow, relatively high yields, and the ability to raise their dividends are attractive.

The holdings in the Trojan Income Fund (tel: 0845-608 0950), run by Francis Brooke, encapsulate these qualities. Brooke works with Sebastian Lyon, and the two have a strong aversion to losing money, rather than just trying to beat an index. Another option is the BlackRock Smaller Companies Investment Trust (LSE: BRSC), run by one of the City's strongest smaller-firms teams. It focuses upon small and medium-sized enterprises with excess cash-flow generation across a broad range of industries.

We expect a production-driven recovery in the West, which should be good for technology. The Herald Investment Trust (LSE: HRI) is a way to invest in smaller-cap technology stocks, with a bias towards the UK. Katie Potts has run the portfolio since inception in 1994 and is supported by a team at Herald Investment Management, dedicated to investments in technology and media. Both long and short-term performance have been very good, yet the shares are on a discount to net assets of about 20%.

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