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.
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.
This year, UK equities will more than likely retain their top spot, albeit it with a slight twist: smaller company funds and those that have a bias towards small and mid-caps seem to be the preference this Isa season – both for growth and for income. With Neil Woodford leaving Invesco, Invesco Perpetual High Income fund is less popular this year and other UK equity income funds are moving up the tables: Artemis Income, Threadneedle UK Equity Alpha Income and Rathbone Income being the main beneficiaries.
According to the latest Barings Investment Barometer, 93 per cent of advisers are favourable to UK equities – up from 79 per cent, the highest level since the quarterly survey was launched. This suggests that they will be steering their clients in this direction too.
The real turn up for the books, however, is European equities. According to the Investment Management Association, this sector has been the worst selling sector for six of the past 10 years. But among one discount broker’s Isa investors, it is currently the fifth best selling this Isa season. Those European companies that have so far survived the European sovereign debt crisis, should be in a reasonably strong position, and this new trend possibly reflects that fact, with investors more confident in their prospects.
However, while UK equities are likely to remain popular, it is clear that emerging market equities are well and truly out of favour. A survey carried out in October indicated that just 4 per cent were considering these areas for their next Isa investment. Couple this with the fact that the main two emerging market franchises of Aberdeen and First State have now closed their funds to new business, and it is perhaps unsurprising that not a single fund in this area is in the top 10 over the past quarter.
According to the Barings Investment Barometer, two in five financial advisers believe their clients should increase exposure to emerging markets, with more than two-thirds of respondents being favourable towards this asset class. These markets are extremely cheap and, over the very long term, investors could be well rewarded for taking the plunge, but I think it will be a hard sell in the coming weeks.
Darius McDermott is managing director of Chelsea Financial Services
Key points
* More than a third of all investments Isas are invested in UK equities
* UK Equity Income funds have been the most popular as the demand for income continues, followed by UK All Companies and Strategic Bond
* Emerging market equities are well and truly out of favour.
