With a new Isa season fast approaching, recent events and prevailing market volatility mean bond funds and fixed-term products should prove popular
The sheer terror and devastation caused on 11 September will forever be etched in our collective memories. Everyone's first thoughts were for the families of the victims but as time goes by and everyday life returns to some form of normality, questions have to be asked about the longer-term ramifications.
The world has changed has been an often-used phrase and while it may be an apt way of conveying the magnitude of this atrocity, it is also open to misinterpretation.
Politically, there is a strong case for saying that things have indeed changed. The almost universal condemnation of the attacks and the building of an international coalition to fight terrorism worldwide are certainly groundbreaking. The realisation that even the most powerful nations can be hurt by such acts is also evident.
But I would suggest that things have not materially changed, in our global stock markets. The global economy was slowing well before 11 September and while events have dented investor sentiment and seriously affected some specific sectors, there is little evidence to suggest that it need have significant long-term impact on markets.
Events like this have been seen before and although the immediate shock to markets is unnerving, ultimately the normal functioning of the market returns and share prices reflect the fundamental earnings potential of companies.
Before going on to analyse what the implications are for the forthcoming Isa season, it is worthwhile recapping on market returns. The table below highlights three phases of recent performance for the FTSE All-Share, S&P 500 and Dow Jones Euro Stoxx 50.
Phase one of this analysis provides a perspective of the prevailing market conditions prior to the attacks. Since the bursting of the technology, media and telecoms bubble in March 2000, central banks and investors had sought to come to terms with a slowing global economy and the implications this had for equity valuations.
Taking a lead from the Federal Reserve, central banks entered into an aggressive period of monetary easing. With tax cuts also on the cards in the US and parts of Europe, the consensus view was that the hard landing would be avoided ' just. Analysts were talking about a recovery starting in the fourth quarter of 2001.
The events of 11 September provided a horrific, yet unforeseeable, shock to the world's stock markets. The US markets were closed for four days, an event unprecedented in recent times, and when they did eventually open, there was an immediate and sustained sell-off over the next five trading sessions.
In this one week, the Dow Jones fell by over 13%, with the airline and tourism sectors amongst the hardest hit. This was perhaps the time of the greatest uncertainty as the market sought to get to grips with the immediate implications and the threat of further attacks.
The third phase of the analysis illustrates the impact of even a very short period of time on market behaviour. Breaking news is soon factored into market expectations and oversold stocks are bought once more on a value bias.
Whether this recovery in share prices continues is the key question for investors. Although stock markets have taken the ongoing military response in their stride, there are clearly still many unknown variables that could have a sudden and equally severe impact on markets.
On the positive side, there is a strong will behind governments and central banks to ensure the orderly and effective operation of markets. Interest rate cuts have continued and, together with tax cuts and increased government spending, should act as a stimulus for the economy and in turn prove supportive for equity markets.
With advisers and fund management groups starting to consider Isa marketing strategies for the tax year end, it is timely to now consider how this year's season will shape up.
There is no doubt that investors are currently risk adverse. The attacks on the US have not in themselves caused this: rather they have been the catalyst, focusing investors' minds on the state of the global economy and the threat of recession. With such a mindset, it is not hard to see why there has been a shift in emphasis towards equity income funds where there is greater transparency and predictability of earnings.
Investor psychology is crucial to understanding and predicting behaviour. It is in the nature of investors to overreact to both good and bad news. Consider the 1999/2000 tax year end when the bulk of Isa sales went to technology-laden growth funds, despite the fact that the market had already risen sharply and valuations were looking decidedly over extended.
In the same way, some investors panicked in the wake of recent events, coming out of the market at what could very well turn out to be the bottom.
Caution is indeed appropriate at times like these but it must be tempered with realism and perspective. At the moment, markets are at multi-year lows sentiment is depressed, valuations are on the most part fair, inflation is under control and interest rates are falling. It is at a time like this that investors would do well not to be overly cautious but instead retain faith in the power of equity markets to deliver over the longer term.
While a lot can change between now and the end of the tax year, the following are the current themes developing in the Isa market.
Investors' demand for lower risk investments will see the continuing popularity of capital secure and guaranteed fixed-term products.
With corporate bonds outperforming both cash and equities over the last year, there is a strong marketing proposition for bond funds being a dominant theme. Quality will be the key and mainstream investment grade funds will be preferred over the high yield alternatives.
Sales of Isas by delivery channel (see table) highlights the powerful role the adviser continues to have. As uncertainty persists, investors will value advice more highly, which should consolidate this position.
Where equity funds are used for Isas, there will be a preference for mainstream UK-focused products. Name recognition and broad fund ranges will be highly valued by investors when selecting fund management groups to use.
As part of cost control exercise, marketing spend by fund management groups will be cut and the number of fund launches significantly reduced. Instead, there will be an emphasis on repackaging/rebranding of existing fund options. (see table above)
It is ironic that at a time when investors are so risk adverse, the underlying economic conditions suggest that a more aggressive stance would be more appropriate for those with a long-term investment horizon. Cutting through the overwhelmingly pessimistic sentiment is often hard for investors but it is here that advisors have an important and powerful role to play.
The forthcoming Isa campaign will be hard for advisors and fund management groups alike.
The challenge will be to persuade investors that their long-term goals are not best served by holding excessive amounts in cash and that discipline is needed during these periods of short-term market dislocation.
As always, balance is the key. Investors will be best served by a well-diversified portfolio that avoids an overreliance on any one investment style, asset class, geographical region and fund management group. Isas are one of the most tax-efficient ways of building such a portfolio and the recent downturn should not be allowed to detract from their undoubted merits.
The global economy was slowing well before the events of 11 September.
Before 11 September analysts were expecting a recovery to begin in Q4 2001.
In risk-averse conditions, there has been a shift towards the earnings predictability of income funds.
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