ISAs: do you want 'sex and violence'?

It's the season for individual savings accounts. Paula Hawkins looks at funds that could revive the jaded appetite of investors

There was a time, not so long ago, when the run-up to the end of the financial year was dominated by one topic: individual savings accounts (ISAs). Street billboards and posters plastered over bus stops and railway stations urged us to invest our £7,000 allowance in voguish funds.

There was a time, not so long ago, when the run-up to the end of the financial year was dominated by one topic: individual savings accounts (ISAs). Street billboards and posters plastered over bus stops and railway stations urged us to invest our £7,000 allowance in voguish funds.

But the equity ISA season, once a billion-pound cash cow in the eight weeks to 5 April, is in danger of becoming a wash-out. Advertising budgets are not what they were and investors' interest has shrunk along with their confidence.

While cash ISAs have stayed strong, figures for 2004, out tomorrow, are expected to reveal that sales of equity ISAs have fallen by as much as 40 per cent year on year; at the end of No- vember, the year's total sales had barely nudged £2bn. Compare this to March 2000 when £880m poured into tech funds alone.

Although a dark cloud may hang over over the ISA season, it is unlikely to be a washout; it's worth remembering that many stock markets, including the FTSE 100, rallied last year.

"There is always an ISA season," says Mark Dampier of independent financial adviser (IFA) Hargreaves Lansdown. "It's always going to tick up because you've got a [5 April] deadline. It's just not going to be much of a tick."

The size of that tick will depend on a seismic change of heart from investors, for sluggish sales reflect disenchantment with a product that has lost much of its appeal.

The Government had planned to slash our equity ISA allowances from £7,000 to £5,000 but it has now shelved that idea, at least until 2009. Last year, however, it withdrew the 10 per cent tax credit that had previously been available on dividend income.

"Maintaining the allowances has given ISAs a bit of a reprieve," says Dominic Cummings of IFA Bestinvest, "but the withdrawal of the dividend tax credit has given a lot of people the impression that the tax benefit has been withdrawn."

This is not the case. While the abolition of the 10 per cent credit means basic-rate taxpayers no longer enjoy any extra benefit for receiving dividends within an ISA, higher-rate taxpayers do since they continue to pay less dividend tax.

And everyone can still avoid capital gains tax on funds held in an ISA wrapper.

Investors who have yet to commit their ISA money won't want to look at how well markets have been performing over the past 12 months; they will want to pick the next winner.

In past seasons there has usually been a theme - such as technology, telecoms or high- yield bond funds - pushed hard to investors. But these funds have tended not to perform well since they had already peaked in value by the time ISA inves- tors jumped on the bandwagon.

It is perhaps a relief that there is no dominant trend this year, but both Mr Cummings and Mr Dampier believe smaller companies funds could still prove profitable.

The trick, Mr Dampier adds, is to find managers who will beat the indices that measure fund performance. "Most of the information you need for this is on the internet and in newspapers; it's not that hard to pick a good manager."

Depending on their attitude to risk, of course, investors are expected to choose funds "with a bit of sex and violence". These include Marlborough Special Situations, which goes for speculative growth, and Aberdeen Far East Emerging Economies, investing in Hong Kong, South Korea, Singapore and China.

"There are still quite a few growth funds about, and these will appeal to bolder investors," adds Mr Dampier.

Equity income funds are expected to stay popular after a strong performance in 2004, but advisers believe it will be a slow year for corporate bond funds, where yields "aren't much better than cash", says Mr Cummings.

However, there may also be some interest in "cash plus" funds, such as DWS Investment's new Ratebuster, due for launch in March. The fund is targeting a high yield of 7.5 per cent with capital protection, though not an absolute capital guarantee. Poor performance could lead to investors getting no return at all.