Pick the right fund when you invest tax-free

There's only days left to use the current tax year's ISA allowance. There's a wide choice

The countdown has begun. There are now just over two weeks to go before the door slams shut on yet another ISA season, so investors' thoughts are naturally turning to which funds have the best chances of delivering decent returns over the coming year.

Will global emerging markets continue to lead the way? Does the recent rally in UK equities have any chance of being sustained? Are we likely to see European equities being derailed by the mounting sovereign debt crisis in countries such as Greece?

The current uncertain market conditions makes it a very difficult decision to make, agrees Justin Modray, founder of website Candid Money. Select wisely and your investment may soar in value; pick the wrong fund and you could lose the lot.

"Choosing investments is a tough call at present," he says. "Inflationary or interest rate increases could hurt corporate bonds while any further economic downturn could be bad news for stock markets, commercial property and some commodities."

The increase in the maximum ISA limits is also likely to focus the mind. From last October those aged 50 and above have been able to invest £10,200 each year, of which £5,100 can be held in cash.

Everyone else is currently restricted to the existing rules of a £7,200 allowance, of which £3,600 can be held in cash. However, the limits will rise to £10,200 for all eligible ISA investors from 6 April, this year.

Mark Dampier, head of research at Hargreaves Lansdown, believes those who can invest up to the new maximum are more likely to split their allowance two or three ways to diversify the risk of having too much exposure to one area.

"This allowance is very generous and I wonder whether the Government will eventually decide they have given us too much," he says. "A couple in their 50s can effectively put more than £40,000 in a tax-free portfolio over the next few weeks."

Consider past performance

Although every investor has it drummed into them that past performance is no guarantee of future returns these figures should still be taken into consideration as it shows that they have been capable of delivering the goods in the past.

It is one of the key attributes that Andy Gadd, head of research at Lighthouse Group, will consider, although he is aware of the potential dangers of buying last year's top performing funds after looking at their performance figures in isolation.

"There could be numerous reasons for their success, such as being in the right sector and in the best part of that sector," he explains. "The manager will have got those decisions right, as well as buying and selling trades at precisely the right time."

We asked Morningstar to compile a list of the best and worst performing funds over various time periods to help provide an insight into the sectors and managers that managed to not only survive the turbulent markets but also make positive returns.

The best performing sectors

Over the past year the best performing sector has been IMA Global Emerging Markets in which the average fund has risen in value by 79.22 per cent, according to figures compiled by Morningstar to 12 March 2010.

It is followed by IMA Asia Pacific excluding Japan (73.34 per cent); IMA European Smaller Companies (71.35 per cent); Asia Pacific including Japan (65.13 per cent); IMA UK Smaller Companies (64.62 per cent); and IMA Technology & Telecommunications (62.14 per cent).

The importance of making the right calls is even better illustrated by the five- year performance figures. Those that had tucked their money into IMA Global Emerging Markets would have made a return of 131.67 per cent return, whereas those in IMA Japanese Smaller Companies would have lost 11.48 per cent and those in Property 10.14 per cent.

The best performing funds over three years

The difference between the best and worst performing funds is quite stark when you consider the three-year performance figures. Top of the pile is the First State Indian Subcontinent fund which has returned 95.46 per cent, according to Morningstar figures to 12 March, 2010, followed by Scottish Widows Latin America (81.15 per cent).

At the other end of the scale sits the SWIP UK Real Estate fund which lost a staggering 60.35 per cent, having done marginally worse that Aberdeen Property Share and TRI European Residential Property.

The best performing funds over five years

Over five years the gap between the winners and losers is even larger. The stand out performer has been Scottish Widows Latin America which has returned a very impressive 265.17 per cent, according to Morningstar figures to the same date. It was followed by Invesco Perpetual Latin America with 245.62 per cent and Threadneedle Latin America on 237.51 per cent. At the bottom of the heap came Legg Mason Japan Equity which was down a depressing 57.67 per cent. CF Canlife UK Smaller Companies was next, having lost 32.06 per cent, followed by the 30.54 per cent loss of Aberdeen Property Share.

Making your choice

Deciding where to place your annual allowance will depend on a number of factors, such as whether you have earmarked the cash for a particular purpose, your attitude to risk, and the areas of the world you expect to deliver the best returns.

One argument is to buy managers that have proven track records of running money in a variety of conditions than worrying too much about specific fund and asset allocation decisions, suggests Mark Dampier at Hargreaves Lansdown.

"I particular like William Littlewood (Artemis Strategic Assets fund) and Philip Gibbs (Jupiter Absolute Return) because they are both funds you can put in the bottom drawer for the next 10 years during which time markets will be hit by all sorts," he says. "Those two – along with Invesco Perpetual's Neil Woodford – are among the finest fund managers in the industry and have the flexibility to buy a variety of assets which is perfect for what is going to be a difficult environment."

Adviser recommendations

So where do the experts suggest putting your money? We asked a panel of prominent financial advisers where we should consider putting our money.

Andrew Merricks, head of investments at Skerritt Consultants, believe that strategic bonds are worth a look, especially in the current environment where it is important not to nail your colours to any one particular mast.

"It is a rapidly changing world and you need to be able to change with it – and that is exactly what a good bond manager can do," he says. "They will have the ability to change their asset allocation depending on where they think the right place is to be."

He suggests the L&G Dynamic Bond fund is worth a look because of its investment flexibility. "We know there is going to be a lot of volatility this year so if you can make money from falling markets via successful shorting that is a tick in the box."

Justin Modray at Candid Money suggests it is wise to have a sensible balance of exposures. Within UK stock market exposure, for example, he favours funds that pay attractive dividends as these can act as a useful buffer should markets fall.

"While I think the long-term prospects for emerging markets and commodities are good, volatility could be high, so it's important to avoid over-exposure to these areas unless you enjoy racy investing," he adds. "Absolute return funds that can benefit from both rising and falling share prices also look a good idea at the moment."

According to Darius McDermott, managing director of Chelsea Financial Services, UK Equity Income is always popular with his clients who believe in the long-term compounding effect of dividends. "We are still seeing reasonable interest in the emerging markets and some of the higher risk plays such as BRIC funds, although there is no money going into Europe or the United States as these are very much the unloved areas."

Mr McDermott believes global income funds are interesting. "They have a lot more stocks to choose from," he says. "We like M&G Global Dividend and Newton Global Higher Income because of their investment processes and track records."

Geoff Penrice at Honister Partners, meanwhile, is drawn to multimanager offerings. "I like Jupiter Merlin Income and Henderson Multi-Manager Income & Growth, both of which hold a wide mix of assets. They can follow a long-term strategy but also make short-term tactical decisions if things change in the market."

Mark Dampier, head of research at Hargreaves Lansdown, believes emerging market funds are running the risk of becoming too fashionable, and suggests ISA investors might be better off looking at other areas, such as Japan.

"It is under-owned, unloved, unfashionable, had 20 years of a bear market and loads of false dawns, but I am buying some now," he says. "

The economy looks awful in every respect but I think there may be an opportunity over the next 18 months, especially for the big exporters, if the Yen falls."

He suggests looking at Invesco Perpetual Japan, Neptune Japan Opportunities and GLG Japan Core Alpha. "You really need to look at buying two or three Japanese funds and get a spread," he adds.

Martin Bamford at Informed Choice believes those investing their ISA for the medium-term should look at a multi-asset fund, such as Jupiter Merlin Income, in order to benefit from diversification across various asset classes.

"If you can afford to take more risk with your money then emerging markets continue to offer an attractive long-term story," he adds. "The Aberdeen Emerging Markets fund has delivered first quartile performance over one, three and five years."

ISA deadline rules: When to apply

Those yet to take advantage of their ISA allowance for the current 2009-10 tax year have until the end of the tax year on 5 April to do so. if you don't use the allowance by the deadline you simply lose it. However, this year the deadline is even more pressing as Good Friday falls on 2 April and Easter Monday on 5 April. It means there are two fewer working days at the end of the tax year meaning savers have less opportunity than ever to beat the deadline and ISA companies have two days less to process applications and transfers.

It means if you leave opening your ISA until the last minute, you run the risk that it won't be processed in time. And if it isn't processed until after 5 April, it will be classed as part of next year's ISA allowance and you will have lost your allowance for this year. If your posting your ISA application, to be sure that it is processed this tax year, ensure it arrives at your ISA supplier by the previous Monday, 29 March.

If you're applying online, you effectively have until midnight on 5 April to complete your application – as long as you can get online then!