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Will investors be cautious or contrarian this Isa season?

Absolute returns, emerging market equities or the return of fixed income: where will the investment opportunities be in the 2013/14 Isa season?

With markets getting off to a shaky start in January following stand out equity returns last year, will investors approach the Isa 2013/14 season with greater caution or opt for contrarian plays on emerging markets and a possible fixed income turnaround?

Despite a bullish outlook for markets and investors’ growing risk appetite last year, net retail Isa sales for the previous 2012/13 tax year actually fell to £1.1bn compared to £2.3bn in tax year 2011/12, according to IMA figures.

The outlook for 2014 by contrast appears less optimistic as recent volatility in emerging markets coupled with the removal of QE and softer economic data in the US has seen equities, last year’s bull story, start the year on a less firm footing.

The MSCI World Index has so far returned -1.4 per cent in 2014 compared to 15.49 per cent for the same period a year previous.

The current backdrop is seeing some advisers adopt a more cautious approach to this Isa season. Bestinvest managing director Jason Hollands stresses the importance of taking a “more nuanced view of markets”.

He says: “This Isa season is very different to last year when we had a very clear and quite bullish view on equities. You saw fantastic returns on developed equity markets last year supercharged with the tailwinds from QE.

“However valuations are obviously much less compelling now and we have also seen the beginning of tapering and the adjustment process in bond markets. So we are going into this Isa season with just a more nuanced and cautious view on markets.”

Hollands looks to absolute return strategies such as Jupiter’s £259.9m Absolute Return fund in line with this cautious view, as a way of benefitting from the greater disparity that is likely to arise in the current market environment.

He says: “For a more cautious investor absolute return funds have not been a very interesting place to be in recent years because QE has essentially driven markets. This has resulted in synchronised returns and high levels of correlation across many asset classes and the impact of company specific factors has been diluted.

“However as we move into a period where stimulus is winding down we expect to see more asymmetric returns between markets and stock selection add greater value, which should be a more conducive environment for absolute return funds.”

Other advisers are adopting a more bullish view for the 2013/14 Isa season, looking beyond any short-term volatility to argue that equities can continue to deliver over the long-term.

Investors could risk missing out on “another good year for equities” by not participating in the current Isa season, according to Skerritts head of investment Andrew Merricks.

He says: “It could well be a theme that investors miss out on the Isa season because of the January dip this year as well as worries about rising rates and inflation.

“However if interest rates remain low and there is a synchronised recovery, which we already appear to be seeing, there is no reason why this year shouldn’t continue to be a good one for equities compared to other assets.”

Chase de Vere head of communications Patrick Connolly is also optimistic on the longer-term outlook for both developed and emerging market equities.

He says: “Although they may be rocky in the shorter-term, we are still pretty happy about the prospects for both developed and emerging markets.

“We are not going to delay or avoid using peoples Isa allowance because we are concerned about the markets at the moment. We aren’t seeing that people are particularly nervous but if they are then we will look at more cautious areas.”

Advisers are split on emerging markets as an investment for the current Isa season.

Merricks is continuing to favour developed over emerging markets while Hollands takes exception to his overall cautious view to recommend that this could be the year to re-enter emerging markets.

“It is very difficult to know when a market has bottomed but actually I think this is the year for people to be looking to drip feed into emerging markets,” says Hollands.

Connolly also highlights the £1.1bn JP Morgan Emerging Markets as a fund that is “best placed to ride out” the short-term volatility that is currently happening in emerging markets.

Advisers are looking to the UK and European equity markets within developed equities for the current Isa season. In particular Hollands draws attention to the £67m AXA Framlington UK Mid Cap and £1.1bn Baring Europe Select funds while Connolly recommends Investec’s £1.2bn UK Special Situations fund for its “contrarian approach.”

Merricks also places focus on smaller companies within each of these markets, pointing to the JP Morgan European Smaller Companies and F&C Asset Management European Assets investment trusts for their exposure to the periphery.

He says: “In the UK it is all about the domestic market and therefore small caps. If as we suspect Europe lags the UK by about six to nine months then the same argument will apply to Europe.”

After falling out of favour with investors, Hollands believes fixed income could also be set to “come back on the radar” at some stage this year, with strategic mandates remaining the best option for building exposure in the current climate.

“We see 2014 as a year of transition for bonds. Fixed income should come back on the radar as the Fed reduces its bond buying programme making yields rise and the dollar strengthen, ” he adds.

Similarly, Connolly recommends strategic bond funds as a way of maintaining exposure to fixed income, although he remains “cautious about the prospects for fixed interest” overall.

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