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Charge of light brigade

The start of the 2003 Isa season has been much like the last one – a damp squib. With UK markets at seven-year lows and investor confidence in the gutter, investment houses have been desperately racking their brains to work out how to get new business through the door.

A year ago, with the FTSE 100 sitting at around 5,000 points after two years of consecutive drops, the ever optimistic fund managers pointed out that the market had not fallen for three consecutive years for more than 60 years and so it was obviously the time to get back into equities.

Most investors were not having any of it. Corporate bond funds or, for the most adventurous, equity income funds, were the order of the day while cash remained king for those who had been most heavily burnt in the technology crash. Never-theless, a few took the advice of the optimists and went back into equities, only to find themselves exposed to another 25 per cent fall in the market.

The 2003 Isa season looks set to split the pack between the realists and the idealists. Several houses are pushing high-octane, focus-style funds, in the hope of persuading investors that the markets are now at their bottom, others are simply continuing to push their equity income and bond funds as hard as they can in the realisation that these will be all they can get out of the door this year.

Standard Life Investments has taken a mix of both these approaches. While its house view is cautiously optimistic for equities in 2003, it has decided to continue pushing its bond funds and also offer an increased commission deal on its recently launched UK opportunities fund.

Standard Life Investments sales director Phil Barker says: “Generally speaking, IFAs and clients alike are apprehensive about stockmarket levels. Most sales we are seeing are going into one of our three corporate bond funds. Groups who have had predominantly equity business will struggle this year. Having said that, we have seen some interest in our new UK opportunities fund from IFAs who feel the market is now undervalued. We feel the UK market does offer some opportunities now.”

Standard Life is one of the few houses to have launched new funds for the Isa season, with most fund managers opting to discount their entire existing fund ranges heavily instead. SG Asset Management, JPMF and Invesco Perpetual have all knocked 2 per cent off the front-end charge of all their funds while most others have discounted their ranges by at least 1 per cent.

Hargreaves Lansdown investment manager Ben Yearsley: “Nobody is going to make any front end at all this year. What with trail income having been hit by falling markets, I think profits are going to be hit very hard in the fund management industry in 2003.”

At 3,500, most fund managers can make a good case for the FTSE 100 being oversold, just as many of them did at 5,000. But the market is no longer being driven by fundamentals, it is being driven by sentiment and necessity. Life companies were being forced to sell substantial proportions of their equity portfolios to stay solvent and the impending war in Iraq continues to cast doubt over many leading companies. The most pessimistic industry observers forecast a floor as low as 2,800 for the FTSE 100.

A quick resolution to the Iraq situation, however, and some solid numbers from the UK&#39s biggest companies could put a stop to the turmoil. The difficulty for investors is that if the market does fall substantially further from here, it could still take them several years to recoup losses. Most believe the recovery will be slow when it finally arrives, with equities growing at no more than 10 per cent a year.

Simpsons partner Andrew Merricks says: “We will probably look back at this time in a few years and realise what a great buying opportunity it was. But there is just not any confidence among retail investors that markets will not go down any more. I cannot see there being an Isa season of any substance. We expect to see a little surge at the end of March but it will be a muted one and much smaller than last year. People have been hammered for a third year running now so they are understandably nervous.”

For risk-averse investors, the 2003 Isa selection does not have much to offer. Just as equities could still see a further slide, the bond market is no safe haven. Nevertheless, UK corporate bonds remained the top-selling sector in December, with the UK other bond sector not far behind.

Credit Suisse Asset Management multi-manager division head Robert Burdett says he is concerned that bond funds continue to be so popular in 2003. “If you look at the last three years, corporate bonds have consistently been the best performing sector,” he says. “It is unusual for any sector to be the top-performing one for three years, let alone four. Default rates have increased and, if you were to strip income away from some of these returns, you&#39re not left with much capital.

“In the UK other bond sector over the last three years – which is where investors have been going in search of higher income – the average fund has lost money on a total return basis and that includes a return of 7 per cent a year income. If you have been withdrawing that, your capital would be down by around 25 per cent.”

Burdett points out that several technical factors have contributed to corporate bonds&#39 success over the past three years but believes these are unlikely to continue driving the market in 2003. Perhaps the most significant of these drivers has been the mass switch from equities into bonds by the life companies. This process is now almost complete, with some life companies now holding almost 100 per cent in fixed interest.

With neither bonds nor equities providing much security, many investors continue to put their funds into the bank or building society. However, with interest rates now at their lowest for more than 50 years, returns are fairly unimpressive.

One of last year&#39s gimmicks was to persuade investors to use phasing options, as a way of dripfeeding their money into the market over a six-month period. But investors have now even become cynical of this, unsure of what the next six months have got in store.

Yearsley comments: “Phasing has not been so popular this year. At the moment, people are waiting for the war. It is harsh but true. A war will not do anything for the fundamentals of the economy but it will take away one level of uncertainty. Overall, less money is being invested this year. A lot more people are sitting on their hands doing nothing and keeping their money in cash.”

It is difficult to paint a happy picture for the 2003 Isa season. Three years of falling markets have damaged the UK equity culture and confidence needs to be restored. However, with some luck, a recovery could start to materialise in the second half of the year, with 2004 offering much more potential.

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