Don't hunt with the hounds: go your own way and bag the best deal this ISA season

Heavily hyped funds might not suit your individual needs as an investor, warns Sam Dunn
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The Independent Online

The financial services industry is counting on us to go stalking for investment opportunities over the next three months - a period it has come to regard as the "individual savings account (ISA) season". And just to make sure, between now and 5 April, when the tax year ends, fund management houses and independent financial advisers (IFAs) will be doing their utmost to encourage us to invest tax-free in ISAs.

The financial services industry is counting on us to go stalking for investment opportunities over the next three months - a period it has come to regard as the "individual savings account (ISA) season". And just to make sure, between now and 5 April, when the tax year ends, fund management houses and independent financial advisers (IFAs) will be doing their utmost to encourage us to invest tax-free in ISAs.

Fund manager Isis is already lining up an advertising campaign to promote James Foster's Strategic Bond fund, which invests in both high-risk and safer, blue-chip companies.

December and January tend to be quiet months in the financial services industry, but all that changes as the new year starts. Advertisements will soon be plastered across billboards and filling the pages of magazines and newspapers - including this one. But don't be lured into a new fund until you've taken a look at your existing ISA investments.

Introduced in 1999 by the Chancellor of the Exchequer, Gordon Brown, to replace personal equity plans (PEPs), ISAs are tax-free wrappers that can be used to hold shares, bonds, cash and even property.

Four years ago, money poured into ISA funds as investors rode the crest of a technology wave. March 2000 was the most popular month on record for ISA sales, with £2.32bn invested, but three years of falling markets have eroded investors' confidence. Fast forward to the 2003 ISA season, and sales for March had shrunk to £410m. Despite this disappointing performance, fund managers are hoping last year's rally on the FTSE 100, which has risen by nearly 14 per cent in the past 12 months, will encourage us to return to equities.

However, many investors are still nursing losses from their ISAs, while mis-selling scandals such as that involving high-income or "precipice" bonds continue to affect confidence. Mr Brown's habit of tinkering with the tax rules is also likely to have a negative effect. This April sees the loss of a 10 per cent tax credit on dividends paid out on equity ISAs, removing a valuable incentive to save. Neither is the Chancellor's proposal to slash the amount you can invest tax free in an ISA from £7,000 to £5,000 in two years' time helping to convince savers he has their best interests at heart.

"This season will be a little better than 2003 but a lot of people still have a hangover," says Ian Smith, the director of IFA Central Financial Planning (CFP).

Last year's surge in the FTSE 100 could lead fund management houses to try to persuade us to invest in equity ISAs, rather than their safer corporate bond equivalents. But he warns investors to beware of opting for a fund simply because it has done well in the past.

"We [often] find people with a portfolio made up of flavour-of-the-month ISAs," he says. "They can be a real mess with a horrible asset allocation."

A good spread of investments - be it in bonds, shares or cash - will give you a comfortable level of risk within your ISA portfolio, says Justin Modray at IFA Bestinvest.

"It's rare that the ISA of the moment tends to be best - it's based on short-term performance," he says. "This year, a lot of investors will want corporate bond funds, but forget the tax benefits and make sure your portfolio is balanced."

Plumping for the most popular investment trend every year can leave you either exposed to too much risk or in danger of missing out on growth in the market. ISA fund fashions seen in the past four years include the technology sector, growth companies looking to expand, shares generating income and corporate bonds.

CFP's Mr Smith points out that funds investing in smaller companies in the UK and in the technology, media and telecoms (TMT) sector did well last year. He expects them to be popular again this year but says that, before buying into them, investors must consider the risk they are taking on. "We usually advise people to have at least two or three funds within their ISA for diversification," he adds.

Money poured into corporate bond funds last year, yet figures from ratings agency Standard & Poor's reveal less than impressive investment performance: the average UK corporate bond fund rose by just 4.56 per cent. If you had opted for a UK equity income fund, you would have achieved average growth nudging 21.12 per cent thanks to the general rise in stock markets.

But a fund shouldn't necessarily be avoided because it is fashionable. IFA Chartwell believes that there is still growth to be had in corporate bonds. Similarly, Trefor Owen-Jones, director at IFA Buckles is backing an equity income fund, New Star's Income, run by Toby Thompson.

Broadly speaking, there are three types of investor - the cautious, the balanced and those prepared to take on more risk. Their individual profile will affect their investment decisions. For example, the emerging Chinese market now being promoted by some fund managers is definitely for those prepared to take a gamble with their cash. Mr Owen-Jones suggests medium-risk investors might prefer European funds. And, as a rule, the more risk averse the investor, the more likely they are to opt for bonds.

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