Investors put on red alert

Will war in Iraq lead to collateral damage on stock markets? Clare Francis gets the experts' opinion

Last weekend the Ark Royal set sail on a journey that may well lead to the Gulf, and further troops have since been despatched to the region. As war fever mounts, financial advisers have been fielding calls from investors concerned about the impact that a declaration of hostilities would have on their holdings.

To assess the potential effects of a war on the stock markets, the independent financial adviser (IFA) Torquil Clark has sought opinions from a number of fund managers. What it has concluded is that much depends on the nature of the conflict, making it impossible to know for certain how the markets will react.

"In the event of war breaking out, it seems likely that stock markets generally would fall suddenly," says Jeremy Knight, co-manager of Legg Mason's European fund. "That said, markets have long been expecting some sort of conflict to take place, and a short-lived war is mostly discounted already. Removal of this uncertainty could even spark a rally in equities. But a prolonged war would clearly put markets under pressure."

While investor concern about a war is understandable, John Hatherly, head of global analysis at M&G, points out that it is only one of various issues affecting the stock markets. Economic weaknesses, difficult trading conditions, profits warnings, accounting scandals and a loss of confidence have all had an impact, creating three years of falling markets. But this is where active management can pay off, as the job of a fund manager is to spot the stocks that are most likely to do well in troubled times.

"Moving into cash and then investing again [when markets look more stable] is the wrong approach," warns Philippa Gee, investment strategist at Torquil Clark. "This will trigger additional charges and create losses. You're unlikely to have access to instant transactions, so you miss the boat on the way out and on the way in. I'd suggest you sit tight and leave the fund manager to deal with the news as it happens. At this stage there are too many 'what ifs' to be playing a guessing game."

Fund managers are prepared should war break out. "I think oil companies are a decent each-way bet," says Richard Prew, director of UK equity retail growth funds at Henderson. "Elsewhere I tend to think there will be modest growth in the market in 2003. Investors should be increasing exposure to some growth stocks but only to the highest-quality names, such as Glaxo, Unilever and Diageo. I'm also more comfortable with the valuations and prospects of blue-chip growth stocks such as Vodafone and BSkyB. This is not specifically to do with Iraq; it's merely that I think things may look a lot brighter after the hostilities."

If we look back to the last Gulf War, markets fell during the months of uncertainty following the Iraqi invasion of Kuwait on 2 August 1990 and the beginning of the military campaign on 17 January 1991. But after a slight dip immediately after military action began, the stock markets rallied.

Assuming the US and its allies achieve a clear victory in any war, Iraqi oil will once again become available, leading to a reduction in prices. "If we were to see oil falling to $20 a barrel, I think markets would [move] significantly higher," says Bob Yerbury, chief investment officer at Invesco Perpetual. "At some stage, this situation will be resolved and, one way or another, Iraqi oil will come back. This will be bad for oil prices but good for the global economy. We just don't know when this will happen."

Despite the continuing uncertainty surrounding the markets, if you've got money to invest, you shouldn't forfeit this year's £7,000 individual savings account (ISA) allowance. There's less than three months left to the end of the current tax year and if you don't use your ISA allowance by then, you'll lose it.

"There is absolutely no point missing out on your ISA allowance for fear of what may happen," says Ms Gee. "More cautious investors can opt for a plan that will take the full amount they want to invest and phase it into their chosen fund over a number of months to stagger the timing of the investment."