One of the less desirable consequences of the current downturn in global markets is that investors will be tempted to sit on their hands and do nothing until there are clear signs of improvement.

While this may be a sensible strategy for those who have already built up significant investment portfolios, for the ISA investor it carries a significant downside.

As we have pointed out on many occasions in What Investment, because there is an annual limit on the amount you can put into them, the way to maximise the tax-free return you can get from ISAs is to ensure that you make contributions each tax year, irrespective of the short-term outlook for particular markets. It makes sense, of course, to vary the underlying investments according to what is happening in the wider market,
but the key driver is to use each year’s ISA allowance before you lose it.

Missed opportunities
This is why the results of Co-operative Financial Services’ annual ISA Intentions Report in February gave cause for concern, as it suggested that 73 per cent of those who had not taken out a 2008/09 ISA by that point, had no intention of doing so before 5 April.

This figure was 13 per cent higher than in the corresponding survey last year and prompted Zack Hocking, Co-operative’s head of investments, to observe, ‘These figures are concerning. Not only do they confirm that many people intend to let their ISA allowance fall by the wayside, but also that reluctance exists to invest in the stock market at a point when many industry experts are saying it could be a great time for investors with a longer-term horizon.’

He points out that ‘Once the deadline passes, that’s it, the allowance is lost forever, and people should not be put off saving despite uncertainty in the economy or the stock markets. If in doubt, they should consider taking financial advice from an expert to ensure that they fully understand the merits of continuing to save.’

There has, understandably, been something of a flight to safety amongst ISA investors, although exactly where this can be found at a time of bank bailouts and pitifully low interest rates is a moot point. M&S Money, originally the financial services arm of Marks & Spencer and now part of HSBC, reports that its M&S Advantage Cash ISA has attracted twice as many new account openings in January as its equivalent product did in the whole of 2008.

This leads Colin Kersley, chief executive at M&S Money, to observe that ‘Financial stability is a priority for savers in these uncertain times, with trust and value becoming key factors for customers when choosing a savings provider.  Record numbers of savers are applying for new cash ISAs with M&S Money or transferring from other providers, and they tell us it is because they have trust in the brand.’

Renewed interest
At the same time, there appears to be a clear divergence of approach between the general public, who seem less willing than ever to commit to an ISA, and those more serious investors who appreciate the importance of taking advantage of their
ISA allowances, year by year. This latter group are clearly altering their strategies
to cope with current difficulties.

Barclays Stockbrokers reports that it has seen a 67 per cent increase in the number of new investment ISA accounts opened compared with a year ago. In addition, 27 per cent of its ISA investors intend to increase their exposure to equities directly due to falling cash interest rates, while 63 per cent of investors believe shares will generate the best returns in 2009.

Barbara-Ann King, head of investment strategy at Barclays Stockbrokers, suggests that ‘For those investors with a long-term view, investment ISAs can offer a route into the market. We are seeing investors actively taking advantage of their tax-free allowance despite market volatility, and it is encouraging to see that their outlook remains positive for the new tax year. Our survey, of 483 Barclays Stockbrokers investment ISA clients, reveals that, as a result of falling interest rates, 42 per cent are reviewing their investment portfolios.’

She adds, ‘We have seen our clients fully capitalising on market volatility so far this year. To date, the buy-sell ratio stands at 63:37. 2009 has also seen a 67 per cent increase in the number of new ISA accounts opened compared with 2008 and “top-ups” to current tax year ISAs have increased by 102 per cent.’

Pressure on savings
Andy Parsons, advice team manager at The Share Centre, observes that ‘Recent interest rate cuts and pressure on saving rates have left cash deposits virtually worthless. With this in mind, now could be a good time for those wanting to make the most of their tax-free allowance to accept some risk and invest in the stock market.’

He adds, ‘The see-sawing markets have, no doubt, left some wary of investing in equities, so to help minimise risk investors need to consider how their investment portfolio is structured. Spreading your money across a range of investments is a good way to reduce your exposure to market risk, as you are not relying on the returns of one investment.’

TD Waterhouse’s CEO, Angus Rigby, reports that ‘With the lowest interest rates on record in the UK and continued volatility in the global markets, our customers are taking a much more diversified approach to their ISA selection this year. Currently, the most popular funds held in our ISAs are those that mix risk with income.’

He adds, ‘The BlackRock Gold and General Account is currently the most popular choice among our ISA investors, and it is also interesting to see portfolios with a varied mix of asset allocation and country specification. Emerging markets, such as China, seem to be popular ISA investment options, with our customers choosing funds such as Gartmore China Opportunities and Fidelity Global Special Situations.’

Angus Rigby confirms that ‘This trend is supported by the results of our recent 2008/09 TD Waterhouse Investor Confidence Index, an independent survey of retail investor confidence in the UK, which showed that 38 per cent of respondents are more likely to invest in Asia over the next 12 months.’

Moving away from cash
Barbara-Ann King feels that ‘Our research shows that cash is no longer king. While interest rates continue to be low, informed investors are taking advantage of the potential long-term returns from investments. It is encouraging that not only have the majority of our clients invested their full ISA allowance this year, but a fifth of our clients are bullish in their outlook for investing in equities in the next tax year, and shares currently account for around 80 per cent of our ISA investments.’  

Parsons affirms that ‘With a diversified portfolio, returns from better-performing investments can help to offset those that aren’t performing as well. Those investors not ready to invest directly in the stock market could consider funds as a way of reducing their overall risk. Funds, by their very nature, help to diversify a portfolio because they include a variety of equities and other investments. Alternatively, those investors feeling slightly braver may wish to consider direct equity investment.’

Angus Rigby agrees that ‘Six successive interest rate cuts have left investors reeling as returns on cash dwindle. Many funds can help shrewd investors to diversify their holdings. This also enables investors to broaden their horizons when managing their portfolio to include more exotic funds or markets they may not have previously considered and at no additional cost. Of course, fund investment is not without risk but there are varying degrees of risk to suit each individual investor’s appetite.’

Moving to ETFs
Another option that is attracting increasing numbers of ISA investors is the burgeoning market in exchange-traded funds (ETFs). Barclays Stockbrokers’ Barbara-Ann King also reports that ‘savvy investors are combining simple and transparent investments like ETFs with the tax benefits of investing through their ISA. Our clients have been using ETFs to achieve diversified market exposure at a low cost.’

She adds, ‘Investors are capitalising on tax-efficient opportunities, with half of our investors holding ETFs within their investment ISAs. Trading in ETFs increased by 162 per cent from October to December 2008, compared with the previous quarter. In addition, the number of accounts holding ETFs increased by 23 per cent.’

King explains, ‘Further analysis of iShares, the ETFs product from Barclays Global Investors, found that the iShares FTSE 100 was the most traded ETF during October, November and December, by a considerable margin. Investors are also revealed to be increasingly using ETFs for income objectives. Corporate bond, gilt and FTSE dividend income-based ETFs accounted for 17 per cent of all purchases during the fourth quarter of 2008.’

She adds, ‘Our clients are increasingly recognising the benefits of iShares as a simple and transparent route into markets and as a versatile investment solution, suitable for
both new traders and their more active counterparts. We have seen unprecedented upheaval in the stock market recently, and confident investors have retaliated through the growing popularity of ETFs.’