Where to invest this year’s Isa? The best rate on cash, if you don’t want to tie up your money, is 3.35% from the AA.
You could go into a bond fund with your stocks and shares Isa and earn about 4%-5%, but there is a risk you will lose capital as interest rates rise.
That leaves equities, but with oil stubbornly above $110 and the eurozone debt crisis back on the agenda, the stock market may be too risky for many investors.
That may be why figures from the Investment Management Association showed an 88% drop in the value of net Isa sales in January to only £21m, compared with £177m in the same month last year.
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Advisers think they have come up with the answer: strategic bond funds. If they have a client who wants income but is worried about the impact of rising interest rates on conventional bond funds, strategic bond funds are an easy sell.
They pay higher yields — about 6%-7% compared with 4%-5% for conventional bond funds — and have greater investment freedom. This means they can avoid the risk of rising rates — or so the argument goes.
Five of the ten best-selling Isa funds sold in February through Skandia, an investment platform, were bond funds. Of those, four were strategic, including Invesco Perpetual Monthly Income Plus, yielding 6.25%, and the L&G Dynamic Bond trust, paying 5.6% Adrian Lowcock of Bestinvest, the adviser, said the L&G fund is one of his picks this Isa season, while Andy Parsons of the Share Centre, the broker, tips the Henderson Strategic Bond fund for cautious investors.
“This has a flexible and wide mandate to exploit upside potential and also to protect capital during more difficult market conditions,” Parsons said.
Now I’m not averse to strategic bond funds — I invested in Henderson Strategic in the dark days of 2008 — but when they are being touted as offering the best of both worlds, as above, it sets alarm bells ringing.
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The argument goes like this. Conventional bond funds invest mostly in investment-grade corporate bonds, issued by quality companies such as Tesco. These have a relatively low risk of default and therefore perform roughly in line with the gilts market. That has been great during the bond bull market of the past three years, but gilt prices tend to fall when interest rates rise.
Strategic funds, in contrast, can invest in high- yield as well as investment- grade bonds. These have a greater risk of default and pay a higher yield to compensate. They are also more geared to the general economy than to gilts. While higher interest rates may be bad for government bonds, they could be good for high-yielders if they herald a strengthening economy.
Nick Gartside of the JPM Strategic Bond fund is predicting a 10% capital gain this year, or a total return of 17% when you add in the income, according to Brian Dennehy of Dennehy Weller, the adviser.
So why am I not rushing to put more into my fund? David Coombs of Rathbone Unit Trust Management says we are at the top of the cycle for high-yield bonds: “They are priced for perfection and at these prices the risk of disappointment is high.”
Prices may not fall as much as for gilts or investment-grade bonds, but they could still fall — and investors who think they are getting some capital protection but growth potential may feel cheated.
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For my Isa this year, therefore, I am planning to bank the 30% profit I’ve made on my strategic bond fund over the past three years and trust it to Neil Woodford at Invesco Perpetual.
The stocks in which he specialises — high-quality blue-chips with solid dividend yields — have been out of favour for three years; surely their time has come.
Kathryn Cooper is editor of the Money section