Cherry Reynard uncovers the themes and funds proving most popular with ISA investors this year...
This year's ISA season presents a radically different set of options to last year. In March of 2013, equity markets were still relatively unloved, fixed income markets still buoyant and income remained at a premium.
A year on and only one of those factors is still present: equity markets have rallied and fixed income has been hurt by Federal Reserve tapering, but the desire for income remains in place.
The dilemma for equity investors is that developed markets now look relatively expensive, while significant problems remain in many emerging markets. It would take a brave investor to re-examine emerging markets, with Russia launching itself into Ukraine, Turkey on its knees and a slowing recovery in China.
In the meantime, bond markets also look unappealing.
Although bonds sold off in the second half of 2013, they have rallied a little since the start of the year and the 10-year UK gilt now sits on a yield of just 2.65%.
The ‘great rotation' finally started to happen in earnest towards the end of last year and the beginning of this one, as investors grew disillusioned with bonds, slowly moving away from the asset class.
The direct to consumer platforms have reflected this trend.
"With the potential of interest rate rises next year, bond funds have not featured among our best-sellers for many months," says Danny Cox, head of advice at Hargreaves Lansdown.
For him, consumers still want income as interest rates remain low but they are looking to equities or property to provide it.
This is echoed by Darius McDermott, managing director of Chelsea Financial Services, who says the group has had no bond funds among its top-selling funds this year, unlike in previous years where they have dominated.
Instead, investors have sought out UK equity income funds, such as the Artemis Income, Rathbone Income and Standard Life Equity Income Unconstrained funds.
A big change within this trend has been the absence of the Invesco Perpetual funds, following the announcement of the departure of Neil Woodford.
"These funds have always been at the top of our list but fell out of the top ten this year," says McDermott.
He has also seen improving popularity for property funds, such as Henderson UK Property, again on the back of an increasing demand for income.
Meanwhile, investors have also strayed into smaller company specialist equity income funds, such as those from Marlborough and Unicorn.
"Smaller companies and smaller company income funds, in general, have been popular. The Cazenove Smaller Companies fund was the top-selling fund on the platform, which investors piled into ahead of its closure. Marlborough and Unicorn were also popular," says McDermott.
Cox has noticed the same trend: "Smaller companies feature heavily given their exceptional track record since March 2009. Any investor brave enough to dip a toe in the water at the height of the crisis early-2009 has probably fared relatively well since," he says.
"As Western economies have begun to recover, consumer and business confidence has continued to improve and the outlook for smaller and medium-sized businesses in the UK, US and Europe looks good."
Investors have generally chosen to spend their risk budget on smaller companies funds in developed markets, rather than stray into the emerging world, which has been going in the opposite direction in terms of popularity.
On the Chelsea platform, for example, Newton Asian Income was dominant last year but drew little support this year.
The open architecture platforms reveal a slightly different picture. Hugo Thorman, managing director at Ascentric, says the key trends on the group's platform have been the number of passive fund purchases and the amount of short-dated bond fund purchases.
There are nine index funds in the top 20 best-sellers, split relatively evenly between equity and bond funds.
But perhaps a more profound trend was the popularity of ‘solutions'. Four of the top ten funds on the platform are mixed asset ‘solution' type funds, showing the continued trend towards outsourcing investment decisions by financial advisers.
The four funds are 7IM AAP Balanced, Fidelity Moneybuilder Income, SEI Core and Dimensional Multi Factor Balanced.
This was a trend seen clearly on the Novia platform as well. However, Bill Vasilieff, chief executive of Novia Financial, says that, while ISA season still exists, it is very different to its previous incarnation.
"There are still greater inflows ahead of the ISA season but almost everything, over 90%, now goes into models. The days of going for this fund or that fund are long gone. Advisers are much more aware of the need to risk assess clients," he says.
Rather than there being a pattern to aggressive or defensive models depending on the market conditions, flows are governed by a client's risk appetite.
The vogue for multi-asset type solutions is even being seen on the fund supermarkets.
Skandia reports that 59% of the net ISA flows in January and February went into multi-asset funds of one type or another. Apart from that, UK equity proved the most popular, taking 36% of net flows, as investors rediscovered their domestic market. Property was the third most popular asset class, as income continued to be at a premium.
On the other side, fixed income drew just 5% of net inflows but UK fixed income proved particularly unpopular, seeing 21% in net outflows. Strong UK economic growth has led many investors to conclude that interest rates will rise sooner rather than later in the UK, making domestic fixed income less attractive.
Equally, there was no appetite to take a risk on newly cheap emerging markets, which saw 10% of net outflows. The Far East and Global Specialist sectors were also unpopular.
While non-advised investors continue to have an ISA season of sorts, ploughing money into the big name funds, advised investors are increasingly taking a different type of approach.
While fund flows certainly increase approaching the end of the tax year, they are not going into the ‘hot' funds anymore. Instead, they are increasingly placed into multi-asset solutions in line with an investor's existing risk tolerance and asset allocation.
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