How to spice up your ISA

Individual savings accounts don't exactly have a reputation for being thrilling; they don't carry the excitement of spreadbetting or taking a punt on a contract for difference.

But lurking inside a rather pedestrian tax wrapper are all sorts of interesting options for investors looking to spice up their portfolio.

But you need to act fast: you have to invest in your ISA by the 5 April deadline if you want to use your annual allowance of £7,200. Up to £3,600 of this can be invested in cash and the remainder in shares.

If you're over 50, your annual allowance is £10,200 and up to £5,100 of that can be invested in cash. This higher limit will be available to everybody next tax year (from 6 April 2010).

There are plenty of opportunities in share-based investments, particularly those that invest in overseas markets, where growth prospects are more exciting than in the UK.

Daniel Clayden, director of Clayden Associates and a chartered financial planner, says: "Some emerging markets are worth considering if you're looking for something a bit spicier.

"Currently, the West is home to the established markets, but give it 25 years and the emerging market economies, as well as Brazil, Russia, India and China [the BRIC economies], will also become established markets, so it makes sense to have your finger in the pie."

Of course, the potential in these markets comes at the price of volatility, but Clayden believes they will yield great rewards over time.

The most popular way to access the emerging and BRIC markets within an ISA wrapper is through a collective fund such as a unit trust or investment trust.

Sharon Segal, a fund manager with Fitzwilliam Asset Management, likes Hexam Global Emerging Markets, run by a boutique house which is a joint venture between Ignis Asset Management and four experienced fund managers.

Meanwhile, Ben Yearsley, an investment manager with Hargreaves Lansdown, favours First State Global Emerging Markets Leaders. For more focused investment in the BRIC economies, he suggests Alliance BRIC Stars, or opting for a single country fund.

He also thinks Japan is worth considering: "Nobody's talking about Japan, but it seems like it is going to devalue the yen, which would be positive for stockmarkets."

Beyond the Far East, other emerging economies the experts think worth considering are Latin America, where Clayden likes Threadneedle's Latin America fund, and emerging Europe, where he singles out Jupiter's Emerging European Opportunities.

As well as geographical opportunities, the experts say certain asset classes offer potential for investors willing to take on more risk. One popular choice is commodities.

Colin McLean, managing director of SVM Asset Management, says: "Commodities closely linked to global growth, such as copper and platinum, should do well.

Oil and gas exploration businesses should also pay off longer term, and gold should maintain its value if inflation grows and may play a part in a new global reserve currency that could emerge in the coming years."

Popular recommendations in this area are JP Morgan Natural Resources fund and BlackRock's Gold and General fund, which is volatile but has had great periods of outperformance.

However, Yearsley warns: "Commodities is a play on emerging markets. Beware of buying both as they are bets on the same things."

There are other, less-loved sectors that the experts believe could be ones to keep an eye on.

Yearsley highlights technology: "People have ignored it for 10 years, but now there are lots of companies with good cashflow and profits. The sector was up 50% last year." He rates the GLG Technology Equity fund.

Similarly, smaller companies have their fans, despite the fantastic run of 2009. Segal says: "I think small and mid caps have more legs [than larger companies].

They tend to do badly in a crisis, but when the recovery starts they have multiple years of rises to help them make up lost ground."

In the rally so far, a lot of the smaller companies that have had gains were lower-quality stocks that seemed unlikely to survive – they rallied when the market decided they were going to make it. Segal believes the rally will continue and will broaden to include quality stocks.

But while there are plenty of funds with something to offer advanced investors, there are also alternatives to the traditional collective investments available within the ISA wrapper.

The first are the 130:30 funds. Clayden explains: "These are split, with one portion of the fund invested in equities and the rest used to generate returns through such techniques as hedge funds and short selling."

This allows the fund manager to simultaneously hold long and short positions on different equities in the fund. Clayden points out that JP Morgan has a range of such funds.

There are also higher-risk options within the Absolute Return sector. These use hedge fund techniques, as well as equities and bonds, to aim for a target return, no matter how the market performs.

McDermott points out: "There are some fairly spicy funds like Gartmore UK Absolute. This has a high target of 10% growth, so has to take more risk to achieve that level of income.

"Or there is Octopus Partners Absolute Return, which reached 40% last year but was down 10% last quarter."

You can also opt for single company shares. The experts favour stocks in a number of sectors. Henry Dixon, a fund manager with Matterley, likes travel and leisure stocks. He suggests airlines on a valuation and top-down basis.

"There will be more corporate activity this year. Airlines like easyJet, Air Lingus and BA are crying out for merger with competitors, and we'll see costs come down – these savings will be passed to shareholders," he says.

Dixon also likes some pub stocks, including Marsdens and Greene King "They're cheap in their own right, and that would be more evident if they merged."

Graham Spooner, an investment adviser with The Share Centre, agrees: "Marsdens' management is well-regarded. It's concentrating on food and being family-friendly, and is a long-term recovery play."

In addition, Dixon favours broadband companies. "There has been an unprecedented growth in the volume of broadband traffic. The companies we expect to make the most of it are Carphone Warehouse, through its TalkTalk brand, and Colt Telecom.

Colt has one of the best bits of infrastructure: over the past decade it has put £5 billion worth of infrastructure in the ground. You can buy the company now for £1 billion," he says.

Similarly, Jonathan Jackson, head of equities at broker Killik & Co, likes Imagination Technologies as a play on the smartphone boom.

"The company is involved in licensing intellectual property for semiconductor design, and its graphics technology is present in the majority of smartphones.

"As a result, Imagination Technologies is one of the best ways to invest in the rapid growth of the mobile internet market," he says.

If you're looking for companies with international exposure, Spooner suggests Tesco. "Many people aren't aware of how international Tesco is.

Its overseas exposure means we favour it over other supermarkets in the UK, regardless of recent changes in market share," he says.

He also likes Coda, which is a specialist chemicals company. It has consistently solid trading updates and the majority of its earnings are overseas.

"A lot of its chemicals go into perfumes and anti-ageing creams, and people tend to keep buying these products even in a recession," he says.

However, stockpicking is only suitable for some investors. Yearsley warns: "If you go for single company shares you need to buy for a good reason. What do you know that the market doesn't?

"What's your edge? You have to do your research or go with gut instinct and be prepared for the fact your gut may be wrong."

In many ways, that's what defines investing at this end of the spectrum. You're taking a risk in the hope of beating the market with a spectacular return, and there's nothing wrong with taking this sort of a risk – as long as you have your core investments elsewhere and you can afford to be wrong.

If this kind of investing is for you, there's no reason why you shouldn't be doing it through an ISA – and saving tax into the bargain.

Self-select versus stocks and shares ISAs

More advanced investors have to choose between a self-select ISA or a stocks and shares ISA with a single fund company. So what are the advantages of each?

Pros of a self-select ISA:

  • Choice of assets: you can invest in shares, investment trusts, gilts, bonds, unit trusts or exchange traded funds from any company.
  • Flexibility: you can buy into any fund and sell up and move easily, without paying excessive transfer fees.
  • Freedom: you can invest in whatever suits your needs best, without the controls of a fund manager.

Pros of stocks and shares ISA:

  • Cost: fees on these funds tend to be lower than self-select ISAs.
  • Spreads the risk: the collective investments within these ISAs automatically diversify your investment between different assets, which may not be possible if you are investing direct in shares, unless you have a large portfolio.
  • Expertise: these funds will employ expert fund managers, so you don't need to research individual stocks.

What about putting an investment trust into your ISA?

If you're considering opting for a collective investment, it pays to consider not just unit trusts, but investment trusts too.

These are like unit trusts in that they are collective funds. However, they have a couple of differences. The first is the way they're structured. They are closed-ended, and to buy into one or sell up, you buy or sell shares in the trust.

The value of the shares is affected by the underlying value of the assets in the investment trust, but also by the demand for shares – in difficult times they'll tend to fall further than an equivalent unit trust, and in better times they'll grow more.

The second difference is that the investment manager can borrow to invest. Daniel Clayden, director of Clayden Associates, says: "If you are looking for spicy investments, you can consider those with more leverage.

That's the beauty of investment trusts: because they can borrow and gear up your investment, a successful investment will produce a higher return.

However, the borrowing will amplify any possible losses too, so you have to be aware of the risk profile of the particular investment trust you are going into."

Buying an investment trust can be done directly through the company or through a self select ISA, where you buy shares in an investment trust in the same way you would buy shares in any other company.

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