ISAs - Self-Select ISA Hints and Tips

The marketing of ISAs tends to be most visible in the run up to the April tax deadline – mostly from fund management groups push- ing the products they think will prove most popular. If you are planning to take the self-select route, though, it is worthwhile having a good look round at the various providers competing in the market. These range from traditional stockbrokers to purely online brokers, financial advisers, fund supermarkets and investment trust managers.

Some managers may offer ISAs that can include only their company’s own products – mainly unit trusts and Oeics. Others may offer a choice of their own and other companies’ products. Somewhat confusingly, the term ‘self-select’ is sometimes used to apply to ISAs covering a wider range of funds, or it may signify that a full range of allowable funds, shares and other securities can be held within the wrapper.

Your choice of account will depend to a large extent on how you plan to run your ISA.

Do you intend to ‘buy and hold’ shares for a lengthy period of time or do you expect to be trading in and out of the market? Is your portfolio going to be built purely from funds, a selection of funds and blue-chip stocks, or are you likely to want to invest in overseas stocks or corporate bonds as well? Are you happy to trade online or would you prefer to deal with a human being over the telephone?

Popular choice

A Self-Select funds ISA is a popular choice with many investors and
offers more options than a standard
in-house funds ISA, without the
complexity and added risk potential of a full-blown self-select stocks and shares ISA. It should enable you to avoid trading commissions and administration fees, with thousands of funds to choose from, many of them with a reduced or zero initial charge. When comparing providers, the essential things to look for are the fund ranges and discounts on offer.

Those who decide they want the fullest possible flexibility from a Self-Select Stocks and Shares ISA will almost certainly graduate to one of the broking services, as such an account should really be viewed as a normal share trading account with a tax-break wrapper around it.

Things to consider and compare when you choose an ISA from a broker include dealing costs, admin charges, any charges for withdrawals and transfers, availability and cost of online or telephone dealing and investor research and support.

If you know other people who trade and invest, get an idea from them of whether they have been happy with the service they use or if they have encountered any problems.

Is the online platform easy to navigate around, responsive and user-friendly? Does it offer useful research to help in making investment decisions? Is it easy to keep track of the portfolio and account activity? Or in the case of telephone dealing, is the service prompt and efficient at all times? Does the account offer an automatic dividend reinvestment option on stocks? Is the broker able to get you an improved price when dealing?

Most Self-Select ISAs are execution-only services, which means the broker will not actually offer any advice but instead merely make transactions according to your instructions. Some more traditional brokers, though, will discuss your portfolio choices with you in return for an additional fee.

Tools of the trade

It is interesting, however, that many online platforms, including those that offer the cheapest dealing services, are offering more and more investor research and in some cases educational tools. This stops short of providing actual advice on specific stocks, but in some cases it’s not that far short – and it has the added attraction of being a free service.

Some brokers will offer access to annual reports, interim reports and other information. At least one gives you free online tutorials covering topics such as building portfolios, setting goals and investment strategies to help you make the most of your investments, while another holds regular free investment seminars for clients.

Market and company information available includes the latest market news, searchable archives, prices and indices, company data and charts. Stock-selection tools are common, helping you filter shares according to criteria such as growth, income, momentum and value. There may also be links to external commentators, articles and opinions, investment tools and stock or fund research.

Other bells and whistles may include stop-loss orders – a safety net trigger that means a share is sold immediately if it falls below a certain level – or purchase price limits, where a share is bought automatically once the price hits a target level.

Dealing costs

Regular traders will want to look for low dealing costs – which are currently under £10 a trade from many brokers – even if they have to pay higher standing charges such as monthly, quarterly or annual admin fees. On the other hand, if you only expect to be trading a few times a year, it could make more sense to go for a provider with lower standing charges but higher costs per trade.

HMRC rules require shares within ISAs to be held within a nominee account, so personal Crest accounts are not an option for ISA investors. Those who feel strongly about this issue may prefer to keep their direct shareholdings outside of the tax wrapper, as the nominee structure is generally a problem if you want to exercise your voting rights directly, attend general meetings or receive any shareholder perks.

However, your broker may be able to help by offering a shareholder rights service, allowing you to remain the beneficial owner, vote and receive shareholder information.

All ISA managers must be authorised by the Financial Services Authority (FSA) before HMRC will approve them. This means that in the unlikely event that things go wrong, clients have access to FSA complaints procedures, the Financial Ombudsman Scheme and the Financial Services Compensation Scheme.

Under one roof

An overriding consideration for those who already have a broker account might be the wish to keep everything under one roof by opening an ISA with the same firm. Certainly this makes it easier to view your investments online. If you already have an ISA and have opened a separate broking account with another provider, you are free to transfer it, although the original firm may charge you for this or insist you sell the investments and transfer cash – something to check on in the small print when opening an account.

Although you can only put money into one Stocks and Shares ISA each year, there are no limits to the number of different ISAs you can hold over time, so to an extent you can try different providers and compare their performance.

 

 Which investment strategy?

Flexibility is fine, but without some kind of investment strategy ISA investors risk running around like headless chickens. ISA promoters like to emphasise the range of funds available and access to a myriad of investments, but in reality no one should expect to spend their time picking from thousands of funds or combing the world’s stock markets.

But how do you plan a strategy? There are three basic issues you need to address before getting down to nitty-gritty buying:

1. Your allowance. Probably the first question to ask your- self is whether you are going to use some or all of your Cash ISA allowance or invest the full amount in a Stocks and Shares ISA. Everyone needs at least a ‘rainy day’ fund to save for emergencies plus, ideally, money accumulating for targets such as a better house, new car, children’s education or holidays. Whether this is held with- in a Cash ISA or outside it is up to you, and only you can know how much you need to have tucked away in the bank to sleep soundly at night.

As long as you do not invest more than the Financial Services Compensation Scheme limit with any one financial group, cash deposits are protected. That does not mean they are ‘risk-free’, though: the risk in this case being that the interest paid does not keep pace with inflation, thus eroding your savings.

That is why many investors seek a higher return from share, bond or property market investments. With the possibility of a higher return, though, comes a higher risk – the chance of the capital value of your investment falling.

2. Do you have the time? Having decided how much of your annual allowance you want to invest in a Stocks and Shares ISA, the next question to address is: how much of your time do you want to spend managing the portfolio? Investors who are seriously interested in the subject and ready to spend hours researching the markets and companies have a head start when it comes to running a full- blown trading ISA. Those of us who want to spend as little time as possible on it would be better off sticking to a limited basket of mainstream funds. Most investors are probably somewhere in-between, so a wider selection of funds plus a few blue-chip shares might be the way to go. Whatever your approach, a fundamental rule is to not put all your eggs into one basket but to diversify between asset classes, markets and market sectors.

Don’t go mad, though: too much diversification across too many holdings will usually deliver you median performance, in which case you might as well save on charges and buy a range of index-tracking or Exchange-traded funds.

3. Investment time horizon. The third question to ask yourself is whether you are a long-term, medium-term or short-term investor.
Active traders look to exploit short-term movements in a stock price: the most extreme of these are ‘day traders’, who are frequently in an out of the market each trading day. For them, the ISA provides a shelter from CGT for their expected quick profits.

Long-term investors, on the other hand, follow a ‘buy- and-hold’ strategy, aiming to make money from a holding over time and weathering periods of volatility or decline. A medium-term investor will not want to hang on indefinitely but will be prepared to take profits or switch from an underperforming investment to a better prospect when this makes sense.

In the longer term, dividends play an important role in generating growth and dividend reinvestment is the key to achieving superior returns. Investors in this camp are more likely to choose investments offering a good sustainable income, such as a top-performing equity income fund or shares in large companies with a proven dividend track record.

 

Managed funds

If you have minimum time to spend on the ISA, a selection of managed funds may be the best way forward. These invest across a mixture of asset classes (shares, bonds, property and cash) in different markets and come in different shades – cautious, balanced or active/adventurous – designed to appeal to investors with varied attitudes to risk.

The next step up would be a portfolio of holdings spread across markets – for example, UK, North American, European and Far East shares, plus some exposure to bonds and property. This can mostly be achieved inexpensively through index-tracking and Exchange-traded funds.

Investors who have more time to spend on research and are more prepared to risk the possibility of their investments failing to match the index performance might want to venture further into actively managed funds, including more specialised products such as smaller companies funds and exotic investments such as emerging markets. We go into this subject in more detail in chapter 6.

Many ISA managers put together their own off-the-shelf packages of, say, half a dozen funds, sometimes with risk ratings to help you choose the right one for yourself. The charges on these funds are likely to be heavily discounted as the broker is able to negotiate a bulk deal. It’s unlikely any firm would be silly enough to promote funds it didn’t think would perform, but nevertheless you should take a look at the performance of these products and make up your own mind whether they represent a good deal.

Going it alone

If you are considering avoiding funds and doing it yourself with direct holdings of shares, presumably you believe you can do better than the professional fund manager, or at least well enough to make it worthwhile not incurring fund charges or management fees. For if not, why bother?

A typical mainstream UK equity fund might have 60-70 share holdings with a strong exposure to FTSE 100 stocks. The manager’s role here is not so much to move completely in an out of companies as to tweak their weightings in his portfolio. As a result, the fund has less chance of beating or underperforming the market index by much.

However a private investor is unlikely to have the resources – time or money - to run such a portfolio. He or she will have a much more concentrated portfolio, akin to a ‘focus’-type fund which has perhaps 20-40 holdings and aims to generate high absolute returns through successful stock selection, rather than a rise or fall in the overall market.

Unless you are taking a very long term
buy-and-hold approach, to run this kind
of portfolio successfully you will probably
need to take a serious approach to
research, following news and comment on the companies you invest in and reading up on the economic and business developments that affect their share prices. Sure, you could just buy one or two shares and minimise the work – but such a narrow spread of risk leaves you more exposed if some- thing goes wrong.

Some investors, mostly active traders, forget about the news-flow and company ‘fundamentals’ such as PE ratios, and focus instead on signals from price chart patterns in a process termed ‘technical analysis’. Whether this works or is just smoke and mirrors is the topic of countless books and articles, but it you want to give it a try Shares magazine has a weekly feature that includes an expert chartist’s tips and opinions on stocks and markets.

 

 

Making the most of your CGT saving

Remember, the only capital gains assessed for tax (outside an ISA) are those you have ‘crystallised’ – paper gains from investments that have not been sold yet don’t count.

The main thing to ensure, then is that you do not exceed your annual capital gains allowance, currently £10,100 a year. With the CGT rate for higher rate taxpayers increasing to 28% in the 2010 Emergency Budget, investors with a substantial holding outside tax shelters such as ISAs or SIPPs could be hit hard when they decide to sell.

Planning your affairs to avoid paying tax unnecessarily is a subject that may require advice from an accountant or tax advisor. However, there are a few simple things you can do – for example, selling some assets to use up your annual CGT allowance and keeping track of any losses so they can be declared and used to offset tax.

The obvious way to avoid tax, though, is to move your investments into a tax shelter. Under HMRC rules, a direct transfer of shares into an ISA is not permitted in most cases and you will need to carry out a ‘Bed & ISA’. This involves selling the holding, moving the cash into your ISA then repurchasing the shares immediately to limit your exposure to price movement.

There is always a catch, of course. Firstly, selling an existing investment and buying it back is still deemed a disposal for CGT purposes, so you must be careful not to trigger a liability by going above your annual allowance. Also, there will be costs involved in transfer- ring to an ISA, including stamp duty, dealing costs and any fund charges. However, future tax free gains could far outweigh any initial transaction costs.

An exception to the rules on transferring shares into an ISA is if you have shares in a company Share Save or Save As You Earn scheme. Shares from these schemes can be transferred directly into an ISA as long as you request the transfer within 90 calendar days of the stock being released from the scheme.

 

 

A shame about AIM

Stock-market investors on the hunt for rapid capital growth will often look at two main potential sources: emerging markets and smaller companies.

Markets such as the BRICs – Brazil, Russia, India and China – can be accessed through direct investment in some shares, but for most investors it is easier to use a fund or investment trust.

When it comes to UK small-cap shares, the LSE’s Alternative Investment Market (AIM) has been the main source of some stupendous gains. The best-known is ASOS, the online fashion company, shares in which are trading for around £15-£16 today compared with 80p five years ago and as little as 3p back in 2001, not long after the shares were first floated. Imagine cashing in your shares for a capital gain of that magnitude, tax-free!

Unfortunately for seekers of ‘ten-baggers’ (investments which grow to at least ten times their original purchase price), the AIM happy hunting ground is largely out of bounds as far as ISAs are concerned. Shares in companies which have a full listing on a recognised stock exchange anywhere in the world can be included, but somewhat bizarrely AIM is not a ‘recognised stock exchange’.

According to accountants Grant Thornton, AIM shares have historically been excluded from ISAs on the grounds that for them to be included would have required their unlisted status for tax purposes to be removed. This would potentially have made them ineligible for inclusion in VCTs and EIS (Venture Capital Trusts and Enterprise Investment Schemes) or for Inheritance Tax business property relief. However, Grant Thornton points out that this argument is inconsistent with the fact that AIM shares are eligible for inclusion in SIPPs along with fully listed shares.

Last year, the LSE was urging the government to alter the ISA rules to help boost a private sector business recovery. So far however there is no sign of any change, which means the only AIM shares you can include in an ISA are those with a dual listing on a recognised exchange somewhere else.

Treasury financial secretary Mark Hoban said last October that by permitting AIM shares within ISAs, there would be a danger people might lose significant amounts of money and with it, their trust in the product: ‘My concern would be by extending [ISAs] to include AIM companies, you are at risk of under- mining the strength of the ISA brand,’ said Hoban. ‘And that might act as a barrier in future to people putting money into them.’ (As opposed, presumably, to shares listed on markets like the Warsaw Stock Exchange, which joined the recognised list in February 2010.)

Of course there’s a risk with small-cap growth stocks like many listed on AIM – but there’s no gain without pain and any investor chasing a big profit needs to be aware he risks losing the lot if a company fails.

Finding a comprehensive list of dual-listed AIM stocks is not easy, and even if you do identify them not all brokers will allow you to trade in them for your ISA. Barclays Stockbrokers is one that changed its policy early last year to allow inclusion and produced a list (see opposite) of the most popular dual-listed AIM stocks, with a heavy concentration in the mining and oil and gas sectors.

Your broker should safeguard you from the danger of investing in ineligible stocks, but it would be wise to check first before buying.

Bear in mind, too, that if a dual-listed AIM stock you hold within your ISA has its secondary listing cancelled, the stock would need to be removed, in which case your options might include selling the stock or transferring the holding into a non-ISA account.

Stocks listed on AIM’s rival, PLUS, are eligible for ISA inclusion. This is little help at the moment, though, as the sole PLUS-listed (as opposed to PLUS-quoted) stock at the time of writing was Mears, which is a FTSE Small Cap company whose shares are already listed on the LSE main market.

 

Choosing a Fund ISA

Dive into the pool

Investors considering pooled funds will find they come in many shapes and sizes and offer exposure to a wide range of asset types. Read on to find out how they work

For a high proportion of investors in a Stocks & Shares ISA, choosing their investment means picking a portfolio of funds. Some readers may be familiar with the ins and outs of fund invest- ing but for others it may be the first time they have come across these vehicles.

There are a vast number of funds around – more than the number of shares listed on the London market – and they come in a variety of guises. So before we get too far into the subject of choosing funds, here’s a quick resume of the basics.

Pooled funds such as unit trusts and Oeics (open-ended investment companies) hold a portfolio of investments in which all of their investors have a share, according to how much money they have contributed – hence the American term ‘mutual funds’. These assets may be shares, bonds, property, cash or derivatives such as futures or warrants.

To allow like-for-like comparison, funds are divided into sectors according to the markets or regions they invest in and their investment objectives – for example, UK Equity Income, Global Growth, Cautious Managed and so on. The IMA (Investment Management Association) classifcation system has more than 30 sectors and is the one with which UK investors are most familiar.

 

Investment trusts

Investment trusts are also pooled funds but with a different structure. They are ‘closed-ended’ companies and their shares are traded on the London Stock Exchange. Their share prices do not necessarily reflect the underlying value of the portfolio – normally they trade at a discount to their net asset value, although sometimes they can move to a premium. Investors can profit when a discount narrows – that is, when the trust is in favour with the market and its share value improves by a greater percentage than that of the underlying portfolio.

In this section, we are looking at ‘open-ended’ funds such as OEICS and unit trusts. Unlike closed-ended funds, their price is correlated directly with the value of their holdings and does not depend on market sentiment. You can invest directly with the fund management company or through an intermediary such as a broker, IFA or fund supermarket.

Oeics and unit trusts

Oeics are similar to unit trusts but structured as companies rather than trusts. Also, unit trusts are divided into equal-value units, while Oeics are said to be divided into shares – a purely technical difference. As far as the ordinary investor is concerned, the two types of investment amount to the same thing.

The return from a fund is made up of its capital growth and the amount of income generated by its investments. Each fund is run by a professional manager, whose job it is to allocate the money and decide when to buy or sell holdings. Normally there is always some money in cash for the manager to use in dealing and at times of market uncertainty a manager may temporarily hold a higher portion by ‘going liquid’. There is no rule about how many companies an equity fund may invest in: its holdings could number in the hundreds or be as low as 20 to 30 firms.

When you want to sell the investment, it is repurchased from you by the fund management group. Daily fund prices can be found in some newspapers and online at sites such as www.fundlistings.com. Fund prices are established regularly by the manager - generally on a daily or weekly basis - but some prices, notably property funds, are updated at less frequent intervals.

Dual-priced or single-priced

With dual-priced funds, you buy at the fund group’s offer price and sell at the bid price. The bid-offer spread is the difference between the two prices. Usually the offer price is higher than the bid, partly because it includes an initial charge.

Single-priced funds have, as their name suggests, one price at which you buy and sell. In this case, the initial charge is shown separately and charged on top of the unit price.

Fund management groups pay the intermediary’s sales commission out of the initial charge: typically this might account for 3% out of an upfront charge of 5%. However, fund supermarkets and discount brokers will often waive or discount this charge on a range of funds.

Annual or ‘trail commission’ may be paid by the fund management company to financial advisers, typically around 0.5% p.a. of the value invested. Again, some intermediaries will rebate a proportion of this cost to their clients.

Annual management fees are generally levied by fund groups to pay for investment management and administration, typically between 0.5% and 1.5% a year. This charge forms part of the fund’s Total Expense Ratio (TER), which includes other charges such as custody and auditing fees and is used to give investors a fuller picture of how much of their money goes towards running the fund.

Some managers impose an exit charge when you sell, which is usually charged instead of the initial fee. It is often only imposed if the withdrawal is made within a certain period, perhaps five years.

 

Income or growth?

Funds may be of the income or growth variety. However, it is common for investors to be offered a choice between accumulation units, where any income is rolled up as capital growth, and income units – even if the fund has ‘income’ or ‘growth’ in its title.

A fund’s distribution yield is a guide to how much income may be distributed to investors over the next 12 months, based on a daily snapshot of the portfolio. It is expressed as a percentage of the day’s mid-market unit price – that is, midway between its bid and offer prices.

Historic yield is used to show the effect of distributions declared over the past 12 months. Underlying yield shows the annualised income after expenses have been deducted.

Funds sold to the public must be authorised by a regulator: in the UK this is generally the FSA, although some funds are authorised elsewhere in the EU, mainly Dublin or Luxembourg. ‘UCITS’ is the standard EU structure for regulating open-ended funds and allows them to be marketed across the community - the letters stand for ‘Undertakings for Collective Investments in Transferable Securities’.

Some offshore funds are based outside the UK and EU in tax havens such as Jersey, Guernsey and the Cayman Islands and are subject to regulation by the local supervisors, with their own investor protection regimes.  Non-UCITS schemes authorized by the FSA for sale to retail investors in the UK are still eligible for inclusion in an ISA.

The simple option

As mentioned in chapter 5,
 if you do not have a lot of 
time to spend on choosing
your ISA investments, nor
for that matter the inclination, then a ‘managed’ fund
may be the best choice.
The nomenclature is a bit
confusing – all funds are ‘managed’ to some extent or other, but some are more managed than others.

Those of you who have had to choose funds for a pension or life insurance policy may well have come across these products before – managed funds are a popular choice for those who want to leave everything up to the provider. Such a fund invests in a mixture of assets designed to meet the risk criteria of the investor. On top of the choice of individual investments, the manager has to make decisions on the overall asset allocation.

The Investment Management Association – the industry body for fund management groups – defines the asset split criteria as follows:

• Cautious Managed:  Funds with a maximum equity (i.e. shares, including convertibles) exposure of 60%, with at least 30% invested in fixed interest (gilts and other bonds) and cash. Assets must be at least 50% in sterling/euro.

• Balanced Managed:  Funds with a maximum equity expo- sure of 85%, with at least 10% of the total fund held in non- UK equities. Assets must be at least 50% in sterling/euro.

• Active Managed:  Funds able to invest up to 100% in equities at their discretion. At least 10% of the total fund must be held in non-UK equities. No minimum sterling/euro balance. At any time, such a fund may include a high proportion of non-equity assets which would other-wise place it in the Balanced or Cautious sectors.

As its name suggests, a ‘Cautious’ fund is less likely to take risks, hence the higher exposure to bonds and cash and lower proportion in shares. There may also be indirect investment in alternative asset classes such as property and commodities, typically using property shares and Exchange-traded funds (ETFs).

By contrast, an ‘Active’ fund is suitable for investors willing to accept a relatively high level of risk, so it will normally be mostly invested in the UK and international stock markets, while the ‘Balanced’ fund is half-way between.

There is, though, quite a lot of variation between funds within each sector. You can check on their asset allocation and investment policy via websites such as www.trustnet.com www.trustnet.com and www.morningstar.co.uk or the fund management companies’ own sites.

The index tracking route

Index tracking funds, as their name implies, aim to replicate the performance of a market index. There are countless indices, covering markets, industry sectors and asset classes, including familiar names such as the FTSE 100 and Dow Jones Industrial Average.

Because there is no active stock selection involved, index tracking funds come with relatively low charges. The manager’s role is to ensure the fund emulates the market performance as closely as possible, adjusting his portfolio to reflect index changes, corporate actions and fund flows.

Some trackers simply buy shares in the companies that make up the index, while others use complex financial instruments to ‘sample’ the index.

Exchange-traded funds do the same job as index tracking funds but cover a far wider range of markets. These are, as their name implies, traded on the exchange in the same way as shares. As well as tracking equities, ETFs (and their close relative Exchange Traded Commodities, or ETCs) give investors access to other markets such as fixed income and commodities such as gold.

Flexibility

There is endless debate about the merits of index tracking funds versus ETFs. Fans of the latter product point to their flexibility, combining the benefits of a pooled fund with the ease of dealing in a listed share, and claim ETFs are more cost-effective.

For most of us, it doesn’t matter much whether we use index-tracking funds or ETFs as long as they deliver market performance efficiently and cheaply. Price-wise, com- petition has been fierce, with the cost of trading likely to stay low or even fall further.

One thing that weighs in favour of index tracking funds is that for ordinary investors, it is generally easier to find simple information on the options available. Navigating your way around ETFs and finding the one you want can be quite frustrating: perhaps because they are widely used by institutions and professionals, the product is not as user-friendly as it could be for inexperienced private investors. By contrast, information on an index tracking fund is usually easy to find at the management group’s website and at comparison sites.

Whichever product you use, you need to be clear on its place in your portfolio. Following an index is not an end to itself but a tool to use within your investment strategy.

Building a fund portfolio

Let’s assume you have decided to progress beyond managed funds and build a fund portfolio yourself, using different funds investing in various markets, sectors and assets. There are certain basic things that need to be decided: do you want to generate income or are you focused on capital growth? If growth is your aim, how much risk are you prepared to accept in the hope of a higher return? Are you a long-term investor or do you expect to need the money within the next few years? And how often do you expect to review the portfolio?

For example, if growth is your aim and you are feeling reasonably adventurous, you might decide to have a port- folio made up of 60% exposure to the UK equity market, 30% to global equities excluding the UK and 10% to government bonds. A more defensive split could be 30% in UK shares, 20% in international stocks, 25% in fixed interest and 25% in gold.

All this can be done using passive (index tracking) investments or actively-managed funds. The permutations are endless, but what they all require, even the simplest, is for the investor or financial adviser to have some kind of a view on the world economy and markets.

This process of asset allocation is ‘top down’ – ie. you start by taking a view on the markets and economies. The opposite is a ‘bottom up’ approach - whereby a fund man- ager believes a good stock is a good stock, regardless of what sector or market it might be found in.

The information game

The subject of what drives world markets has filled count- less books and expert articles. It’s very easy to get buried in information and opinion. However, all you should need to do at this level is stay reasonably well informed on economic developments in the UK, US and any other markets you might want to invest in.

Of course, the most important thing for any share investment is the profitability of the companies you are investing in. It’s not difficult to form a view on the health of the corporate sector in major markets by following day- to-day news and comment. However, currency movements are also a vital part of the picture when you are considering overseas investment because they directly affect your returns. The performance of a US equity fund, for example, will look better to a UK investor if the dollar strengthens against sterling.

A common approach is to put together a portfolio with an equity component made up of UK, US, Europe ex-UK and Japan, Asia Pacific or perhaps emerging markets funds in varying proportions. If you do go down this route, it makes sense to stay on top of developments in the various regions and at least consider adjusting the weightings once in a while.

Emerging markets

Some markets are more volatile than others and require closer attention. The BRICs – Brazil, Russia, India and China – have been in vogue of late and can be accessed via funds, ETFs and investment trusts. Any emerging market investment carries a higher potential risk or return than, say, a mainstream UK or US fund. However, you can mitigate the risk by investing in a general emerging market fund rather than focusing resources on a single-country investment.

To backtrack for a moment, your portfolio mix should partly depend not only on your attitude to risk, but also your likely investment time horizon. If you are unlikely to need access to the money for the foreseeable future, it’s easier to be more heavily weighted towards share funds, as even if stock markets take a dip you can afford to wait for them to bounce back. Property funds are also best viewed as longer-term investments as there may be restrictions on withdrawals - particularly in difficult market periods.

Anyone who will need to take an income from their investments in the near term is usually recommended to move progressively from shares into bonds or cash. Those saving for a particular goal will also need to think about moving their fund portfolio towards a safer harbour at some point.

Hedge your bets

If you want to hedge your bets a little, one strategy is to take a ‘core-satellite’ approach, setting up a portfolio with a group of lower-risk investments at its heart surrounded by a selection of others offering potentially sexier returns. The relative sizes of the core and satellite parts will depend on the individual, but you could select a Cautious or Balanced Managed fund for, say, 40%, with a 10% bond fund holding and the rest spread across UK, regional and specialist funds.

Fund selection

Investment professionals spend a lot of time researching funds, examining the quality of management, performance and investment and applying analytical techniques to identify the products they want to do business with.

Private individuals have fewer resources and fewer hours to spend poring over funds, but you can still improve your chances of picking a winner.

One maxim often quoted in the marketing is that ‘past performance is not necessarily a guide to future performance’. This is true up to a point. A fund may have performed well because the market cycle at the time suited its investment style. Maybe it did well under a top manager who has since left. Or maybe it just got lucky.

Be that as it may, a fund’s past performance will certainly give you an idea of whether it is worth considering for investment or whether it’s a real ‘dog’. Using an online site, you can view fund performance over different periods, such as one, three and five years, ranking all the funds in a sector from best to worst and comparing them with the sector average.

Few funds manage to achieve top-quartile performance - that is, appear in the leading 25% - all of the time. But if a fund has managed to deliver outperformance some of the time without dipping much below the average for any one period, the chances are that it’s worth a look. Check against a relevant index too: for example if you are looking at the UK All Companies sector then see how the funds have performed versus the FTSE All-Share.

Once you have a short-list of funds in a sector, take a closer look to see what makes each of them tick. You may find big differences. Even some actively-managed funds are ‘closet trackers’, investing in the main stocks that make up each index and just tweaking the weightings – their performance is never likely to vary by much more than a few percentage points from that of the index. By contrast, other funds will go out on a limb, placing bigger bets on the manager’s favoured stocks.

You may be able to find information on the fund’s ‘beta’, a useful statistical measure. A fund with a beta of greater than one will have historic returns or losses greater than those of the market, while a fund with a beta of one moves in tandem with the market.

Many investors like to follow a ‘star’ fund manager – one with a distinctive investment style, creative ideas and above all a good performance track record. Bestinvest.co.uk produces an online list of the top fund managers in different sectors and across varying periods. The same firm also produces an annual ‘Spot the Dog’ guide to the worst-performing UK funds.

 

Investment styles

Fund managers have different styles, and it is as well to know what style yours is following as it could affect the way the fund performs in different market conditions. The biggest difference in emphasis is between ‘value’ and ‘growth’.

Value managers look for shares where the price of equity does not truly reflect the company’s fundamental value, typified by low PE ratios. On the other hand, growth managers seek companies with potentially strong future earnings growth, characterised by higher PE ratios. Each style will do better than the other at a particular time, depending on where we are in the market cycle.

‘Multi-manager’ funds have grown in popularity over the last couple of decades. They take the fund selection weight off the investor’s shoulders by employing a professional manager to put together a portfolio of funds.

Managers of these funds tend to look for underlying investments that are ‘uncorrelated’, so that their different styles provide portfolio diversification. Because of this, a multi-manager fund is unlikely to top its sector but if it’s working properly should never be far below the median, either.

Expenses in these funds tend to be higher as there is another level of management to pay for, so check the TER (total expense ratio) to make sure it is not too out of line with single-manager funds.

Multi-manager fund investors should also keep an eye out for ‘fettered’ funds, which are restricted from investing in funds outside the same management group as the overall fund. Most ‘funds of funds’ are ‘unfettered’, meaning the manager can take advantage of the best funds from other management groups.

 Other types of fund you are likely to come across include:

• Special situations funds: Funds that focus on investment in undervalued companies with the potential for share price gains due to specific circumstances.

• Recovery funds: Focusing on investment in companies with recovery potential after their share price has fallen.

•Ethical or ‘socially responsible’ funds: Those which avoid certain sectors such as tobacco, alcohol and arms manufacture. ‘Green’ funds invest in environmentally friendly companies.

• Focus funds: Those which invest a large portion of their portfolios in relatively few stocks. •Absolute return funds: Funds aimed at delivering absolute returns, as opposed to returns relative to a benchmark index, in any market conditions by taking long and shortstock positions.
 All of these are interesting variations and

can add some spice to your portfolio. ‘Green’ funds will appeal to many of us and, as it hap- pens, there is some evidence to show that companies with a good environmental record do deliver better performance.

However, be careful not to fall into the trap of investing in ‘flavour of the month’ funds. The first discipline is to decide on your asset allocation, based on your attitude to risk versus return, then to slot in the best funds for the job after researching the options. Depending on how much you have to invest, you may also want to blend funds with different styles in the same sector which compliment each other and reduce risk.

A number of larger brokers provide recommended off-the-shelf packages of funds for different types of investor, and some have online tools and models to help you put your own portfolio together.

 

Remember that your full ISA allowance does not have to be invested in one go. You can spread it out over the year, flattening out the market’s peaks and troughs.

 Specialised ISAs

 

Something different

Not everyone’s the same when it comes to investment preferences, but the good news is ISAs can cater for a range of specialised products.

We’ve already explained that there are two kinds of ISA – a Cash ISA and a Stocks and Shares ISA. So what does it mean if you get something through your door promoting an ISA with a different name altogether?

Don’t be confused – whatever their managers call them, all ISAs must be one of two kinds of animal. Most of what comes your way bearing a different label will be a pooled fund-based Stocks and Shares ISA with a particular investment angle. Essentially, it means the provider has taken some of the work off your hands by offering a package based around a particular type of investment, normally restricted to products from the provider’s own range, although some may look further afield.

For instance, an ‘Investment Trust ISA’ is marketed by some institutions offering investment in the trusts they manage. However, investment trusts are also generally available for inclusion in any full Stocks and Shares ISA and shares in them can be traded freely on the stock market.

One attraction is that the Investment Trust ISA may pro- vide a regular saving option with a relatively low minimum and free or low-cost dealing. Apart from that, though, unless you are going to restrict your ISA to a narrow range of investment trusts it’s difficult to see the point.

 

Ethical investments

There are several ‘Ethical ISAs’ around. If you want to simplify the process by going straight to a single provider for a socially responsible investment, they could do the job. However, a full Stocks and Shares ISA will give you total access to the wide range of ethical and green unit trusts or Oeics on the market, enabling you to compare performance, check out the funds’ investment criteria and switch funds whenever you feel like it.

The same applies to corporate bond ISAs, high -income ISAs or any other branding the providers come up with: all you’re really getting is a restricted fund choice.

To repeat what we said earlier in this guide, an ISA is just a tax wrapper. Apart from the rules setting out the allowable investments in a Cash ISA or Stocks and Shares ISA, what you put inside your wrapper is up to you. However, there is no rule that says the provider of a particular ISA has to give you access to the whole range of investments – hence the number
of products which are really just offering you a limited menu of funds.
The arguments for buying such products are possibly that they are simpler to arrange and that the initial costs are lower. On the other hand, dealing through some of the avenues we have already mentioned – such as online brokers and fund supermarkets – is straightforward once you have set up an account, and you may find they offer competitive discounts on the funds in question.

If you only have a modest amount to invest each year, it might make sense to invest in a single-fund ISA and build up a portfolio of funds over a period of time. You will still have all your eggs in a few baskets for a while, though – remember, you can only take out one Stocks and Shares ISA in each financial year – so be sure the fund looks a good prospect before going ahead.

 

Structured products

So-called structured products have proved popular with private investors, particularly at a time when share markets were looking turbulent. In 2009, according to the UK Structured Products Association, nearly 50% more money was invested in structured products than went into Stocks and Shares ISAs for the 2008/09 tax year. This was no doubt because they offer some degree of assurance in an uncertain world.


Structured products are created by financial institutions such as banks, life insurance groups and wealth managers. They typically link the return on your capital to the performance of an underlying security, often a stock market index such as the FTSE All Share.

Some structured products offer capital protection, guaranteeing to repay the initial investment when the product is held for the full term. Others provide partial protection, repaying the initial outlay as long as the underlying security has not fallen below a certain level during the term.

There is much variation between these products as each is financially engineered to do a particular job. The provider will use a major part of the investment to buy a ‘zero coupon’ bond, which will return a fixed amount at a set point in the future. This will provide the capital protection element, but will not pay any interest in the meantime. The rest of the investment is used to buy the other part of the structure, aimed at producing capital growth or income, via financial derivatives.

 

Risk and return

There is, as always, a trade-off between risk and return – the more capital protection you have, the less you can expect to benefit from performance in the underlying market index or other asset.

Most structured products have fixed terms but there is a new style of ‘kick out’ product becoming more popular, in which the scheme comes to an end once its return objectives have been met.

Part of the attraction of structured products
 is that they allow investors to enjoy some of the performance from a market while protecting their
capital from losses. They also offer access to markets which may not be easily accessible to the private investor. The range of products on offer these days is so wide that an investor should be able to find one to suit his or her objectives and attitude to risk.

When considering a product, check on the exit terms, as withdrawing money early may result in high charges. These products may be complicated, so make sure you have understood exactly what is involved before committing your- self and if necessary consult an independent financial adviser.


It is important to check the structured product you are considering qualifies for inclusion in an ISA. The rule is that to be ISA- eligible, the product has to have the ‘potential’ to run for five years from the date of issue. Last year, there was some doubt about the eligibility of kick-out plans until HMRC reconsidered its earlier position and confirmed they qualified. It is the ISA manager’s job to ensure an investment is allowable and you should be able to rely on a clear statement from a provider that this is the case.

There are also deposit-based structured products available, otherwise known as structured deposits, which can be held in Cash ISAs. These are term deposits, similar to a fixed rate bond, but with a variable rate of return. Like their investment brothers, the return from structured deposits may be linked to the performance of an index or security and offer capital protection. The five-year rule does not apply to structured deposits.

 

This ‘How to’ guide is produced by Shares Magazine and is only for general information and use, and is not intended to address particular requirements.

The value of investments and the income derived from them can go down as well as up. Past performance is not necessarily a guide to future performance.

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