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.
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.
Selling of a security (mainly shares) that the trader does not own. The shares are borrowed from a long-term investor (a pension fund), sold into the market and, when the shares fall in price, they are bought back at the lower price and then returned to the lender with a small commission. The short seller’s profit is the difference between the price at which the borrowed shares were sold and the price at which the borrowed shares were bought back.
Sometimes known as a trading ISA, a self-select ISA gives investors full control over which assets to include in their ISA, allowing them to choose individual shares and bonds rather than investment funds. Aimed mainly at experienced investors and subject to the same investment limits of a regular ISA, a self-select ISA will usually be managed by a stockbroker on an investor’s behalf.
Investment trusts are companies that invest money in other companies and whose shares are listed on the London Stock Exchange. As with unit trusts, private investors buying shares in an investment trust are buying into a diversified portfolio of assets (to reduce risk), which is managed by a professional fund manager. Investment trusts differ from unit trusts in two important ways: they are listed on the stockmarket and so are owned by their shareholders and are closed-ended funds with a finite number of shares in issue. This means the share price of investment trusts might not reflect the true value of the assets in the company (known as the net asset value, or NAV) and if the NAV value of a share is £1 and the share price in the market is 90p, the trust is said to be running a discount of 10% to NAV. But this means the investor is paying 90p to gain exposure to £1 of assets. Investment trusts can also borrow money and use this money to buy investments. This is known as gearing and a geared trust is thought to be more of an investment risk than an ungeared one.
A collective investment vehicle (known in the US as a “mutual” or “pooled” fund) and similar to an Oeic and investment trust in that it manages financial securities on behalf of small investors who, by investing, pool their resources giving combined benefits of diversification and economies of scale. Investors buy “units” in the fund that have a proportional exposure to all the assets in the fund, and are bought and sold from the fund manager. The price of units is determined by the value of the assets in the fund and will rise or fall in line with the value of those assets. Like Oeics (but unlike investment trusts) unit trusts and are “open ended” funds, meaning that the size of each fund can vary according to supply and demand of the units form investors. Unit trusts have two prices; the higher “offer” price you pay to invest and the “bid” price, which is the lower price you receive when you sell. The difference between the two prices is commonly known as the bid/offer spread.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
A catch-all phrase that can range from assessing the price of a property or vehicle before offering it for sale or the net worth of assets in an investment portfolio to the prices of shares on a stock exchange.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.
A term applied to raw materials (gold, oil) and foodstuffs (wheat, pork bellies) traded on exchanges throughout the world. Since no one really wants to transport all those heavy materials, what is actually traded are commodities futures contracts or options. These are agreements to buy or sell at an agreed price on a specific date. Because commodity prices are volatile, investing in futures is certainly not for the casual investor.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
An individual employed by an institution to manage an investment fund (unit trust, investment trust, pension fund or hedge fund) to meet pre-determined objectives (usually to generate capital growth or maximise income) in prescribed geographic areas or investment sectors (such as UK smaller companies, technology or commodities). The manager also carries the responsibility for general fund supervision, as well as monitoring the daily trading activity and also developing investment strategies to manage the risk profile of the fund.
A sophisticated absolute return fund that seeks to make money for its investors regardless of how global markets are performing. To that end, they invest in shares, bonds, currencies and commodities using a raft of investment techniques such as gearing, short selling, derivatives, futures, options and interest rate swaps. Most are based “offshore” and are not regulated by the financial authorities. Although ordinary investors can gain exposure to hedge funds through certain types of investment funds, direct investment is for the wealthy as most funds require potential investors to have liquid assets greater than £150,000m.
The familiar name given to securities issued by the British government and issued to raise money to bridge the gap between what the government spends and what it earns in tax revenue. Back in 1997, the entire stock of outstanding gilts was £275bn; by October 2010 it had surpassed £1,000bn. Gilts are issued throughout the year by the Debt Management Office and are essentially investment bonds backed by HM Treasury & Customs and considered a very safe investment because the British government has never defaulted on its debts and this security is reflected in the UK’s AAA-rating for its debt. Gilts work in a similar way to bonds and are another variant on fixed-income securities.
An acronym, which stands for Brazil, Russia, India and China; countries all deemed to be at a similar stage of advanced economic development. The term was coined in 2001 in a report written by Goldman Sachs director Jim O’Neill who speculated that, by 2050, these four economies would be wealthier than most of the current major G7 economic powers.