Isa Season: Banking on UK equity income

In addition, inflation finally dropped to the Bank of England’s target 2 per cent for the first time in four years and job numbers improved significantly, with unemployment falling to 7.1 per cent, also the lowest level for four years.

While the health of an economy often has little correlation with investment returns, the FTSE 100 also had a very strong 12 months, returning more than 18 per cent. The average UK equity fund did even better, returning almost 26 per cent.

Now, more than a third of all investment Isas are invested in UK equities, and I imagine most smaller Isa investors have significantly higher exposure than this to our domestic market. So many investors will be quite happy at the moment.

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The trouble is, there is quite a bit of talk about the UK stock market no longer being cheap, and Mark Carney, the governor of the Bank of England, has quite publicly questioned the sustainability of the economic recovery we are currently enjoying.

According to Mr Carney, interest rates are likely to be pegged to the ultra-low level of 0.5 per cent for the rest of 2014 and beyond, as the UK would struggle to cope if emergency measures were brought to and end today. While a few quarters of above-trend growth are a good start, he said, the UK economy still remains smaller than it was in 2008 and there are mounting risks to the global economy posed by problems in emerging markets.

Rhys Petheram and Alastair Gunn, managers of the Jupiter Distribution fund, agree. They say that, while the UK economy is looking healthier, so far economic growth has come through a reduction in the savings rate, alongside some employment improvement - it has been a consumer-led recovery. What we have not seen yet is the recovery being supported by business investment or wage growth and a rate rise too early could end up making mortgages more expensive and discourage business investment.

So will these notes of caution put Isa investors off UK equities this Isa season? I do not think so, if current trends among our investors are anything to go by.

The past couple of years have seen a slight swing away from bonds to equities, but in general, the trend has been pretty similar: UK Equity Income funds have been the most popular as the demand for income continues, followed by UK All Companies and Strategic Bond, then Asia Pacific ex-Japan and Global equity funds making up the top-five selling sectors.

When it comes to individual funds there has also been little change at the top: Invesco Perpetual High Income and Invesco Perpetual Monthly Income Plus have dominated, as the search for income continues. Asian equities in the form of Newton Asian Income and First State Asia Pacific Leaders have been popular both years, as have M&G Global Dividend and M&G Recovery.

The changes that have occurred is that bond funds have fallen out of the top 10 to be replaced by more UK equity and equity income funds, as fears of an end to quantitative easing and rising interest rates have put people off buying more fixed income.