Could the equity ISA be making a comeback? There are signs that investors feel more comfortable betting on the stock market than they did last year.

A survey by Scottish Widows Investment Partnership sums up the general mood. It asked whether sales would be higher or lower than 2005 and by how much. More than three quarters of financial advisers expected a modest lift in sales, with an average predicted growth of 11%.

But many private investors remain uncertain about where to invest their money. A separate survey of more than 2,000 investors, conducted by New Star Asset Management, found that nearly half were unable say which asset class would perform best in 2006. Of the rest, a quarter opted for buy-to-let residential property. One in 10 picked commercial property, while only 5.1% opted for UK equities and 4.6% for global equities. Making up the numbers were cash with 3.7% and bonds with 3.2%.

The results are not surprising at a time when there are still PEP and ISA investors nursing losses from the slump in values following the 2000 crash. Even those investors in positive territory are nervous about the future for equities, especially in the US, UK and the rest of Europe.

Investors want to believe that equities are returning. They look at the FTSE 100 and the 70% rise on its low point in 2003 and want to believe it can go on and on. However, the financial advisers’ mantra that stock markets always outperform over the longer term looks shaky.

The changing corporate landscape, with increased overseas competition and extra costs, such as pension contributions, has made large companies appear heavy footed and unlikely to produce consistently strong gains. Then there are the fears over Iraq, further terrorist attacks and the lingering suspicion of the financial services industry following the personal pension and endowment misselling scandals.
So it won’t surprise most advisers to hear that predictions of more gloom, in the shape of a difficult year ahead for the British economy, is likely to encourage ISA buyers still interested in equities to look east.

Japan, emerging markets and natural resources were the best investments last year. Seven of the 20 top-performing funds, as measured by Lipper, were Japanese specialists; five were general emerging market funds; six specialised in emerging regions, such as Korea, Russia or Latin America; and two were energy funds.

Among the top performers in the Japanese market was Framlington Japan, run by Anja Balfour, which established a strong track record at Baille Gifford and Stewart Ivory. Money Observer magazine picked her fund as its best Japan fund in its 2006 investment awards. She has shifted the fund out of smaller stocks and into larger ones following what she believes is a realisation, especially among Japan’s banks, that reform was overdue.

Her tale contrasts with other top performers that have subsequently fallen from grace.

Specialist Japanese funds were popular six years ago ­ the last time investors bet the country could drag itself out of deflation. The bet was judged wrong after two of the best-performing funds, Invesco Perpetual’s Japan Smaller Companies and JP Morgan Japan, plunged to the fourth quartile just 12 months after showing spectacular gains.

Will Balfour’s fund follow suit? She is confident the political and economic scene in Japan is set fair. Other commentators will prefer to bet on the bull run in natural resources stocks. JP Morgan Natural Resources remains a strong performer. After five years, it has turned an investment of £100 into £384 and stayed in the first quartile in its sector all that time. JP Morgan also scores highly among emerging markets funds. Its New Europe fund is small compared to the Natural Resources fund (£54m compared to £560m), but it managed to push a £100 invested five years ago to £293.

Money Management magazine’s latest ISA performance tables for a lump sum investment of £1,000 is full of the esoteric or exotic. Scottish Widows Latin American A fund, First State Asia Pacific, Baring Korea Trust and Merrill Lynch’s Gold & General all rank in the top 20 funds. For the best results last year, investors needed to put all their money in Latin American funds, most of which added 80% or more.

But sophisticated financial advisers like accountants don’t need telling that today’s stars can be tomorrow’s dogs. It is easy to pick on the New Star technology fund as a lesson in what can happen to once high-fliers. More instructive would be to recognise that, among Money Management’s 20 worst performers, more than half were American Growth funds. While many of them rely heavily on technology stocks, they have the kind of name and billing that persuaded investors to look for long-term, consistent gains.

That kind of analysis leaves the adviser who wants to avoid disaster looking at the brand names of the fund management world ­ Neil Woodford at Invesco Perpetual and Anthony Bolton at Fidelity probably head the list. Bolton’s Special Situations fund, which has mostly taken positions in small and mid-cap companies, is Britain’s most popular unit trust. During the past three years, he has turned a £7,000 ISA investment into £12,719, at a time when the average fund would have grown only to £10,633. An investor who put £1,000 into the fund in 1979, would today see its value at more than £100,000. Bolton wants to retire in 2007, so maybe the party is about to end, but Fidelity says it is the brand and not Bolton in control.

If buying into his fund feels too much like following the herd, then there are the increasingly popular multi-manager platforms offered by some of the larger players. Jason Hollands, head of communications at F&C Asset Management, says many financial advisers want to focus on offering client services such as tax and pension planning, but leave day-to-day investments to a third party. F&C offers four fund collections of between 20 to 25 funds. Fidelity focuses on its Special Situations and Equity Income multi-manager funds, which now account for £20bn of business.

John Chatfeild-Roberts at Jupiter narrows his portfolios to 15 or 20 funds from the near 2,000 unit trusts on offer. Whether you look at income or growth his results are impressive. The Merlin Growth portfolio is up 36% over the past 12 months, and 114% over three years, although it fell during 2001 and 2002.

Chatfeild-Roberts’ big success during 2005 was to pick not just the overall best performing trust of 2005, but the one that came second too. Among the 17 trusts in which he invested was Melchior Japan Opportunities. This trust topped the tables in 2005 with a 94.1% gain.

Can he repeat his success this year? Some believe he would need to become a Bric (Brazil, Russia, India and China) supporter. In a balanced portfolio, embracing Bric might be a risk worth taking.

Phillip Inman is a freelance journalist

Buy-to-let ISAs

For the past five years, the British have poured their spare cash into buy-to-let flats. But until this year, there were no tax-free advantages to property investment. Now that’s changed and commercial property trusts can be part of an ISA portfolio.

Inflows to property funds have quadrupled in recent years as the lure of growing rental returns and sometimes huge asset growth takes hold.

For instance, the Scottish Widows Investment Partnership Property Trust claims an 18.48% return since its launch in November 2004. New Star claims double-digit growth in each of the past three years and an income yield of 4.1% at 31 January. Norwich Union and Legal & General have made their property trusts eligible to be put into an ISA.

Some believe a switch to property will transform the ISA market and more than £12bn of the £82bn held in Peps and ISAs is likely to make the move. To anyone with a full complement of ISAs (with contributions of £49,000 since their launch in 1999) it might seem like a reasonable strategy to diversify.

Tempting though it may appear, some commentators remain wary. Mark Dampier, head of research at one of the country’s largest independent financial advisers, says commercial property could easily become unloved and unwanted, just as it was 10 years ago. Other experts agree, arguing the flood of speculative building in most large cities will almost certainly lead to an oversupply and a fall in rental yields.

Others argue that, while commercial property prices are unlikely to rise much further and as yields fall, inflation takes a larger slice out of returns, there is a positive note ­ there is no sign of a crash. And there are several strong property companies, such as Hammerson, with portfolios extending beyond our shores and with strong growth records, on which property trusts can base their investments.