Look east for high ISA returns with a fund invested in Asia

Philip Salter
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Despite interest rates that are no match for inflation, savers still fail to make full use of their ISA allowance. However, if they are saving for the long-term, and are prepared to deal with volatility in the short-term, they might be better off using their ISA allowance to invest in an Asian exposed fund instead.

Although noteworthy in simplicity, there is nevertheless confusion as to what an ISA actually is. Many savers don’t realise that it is a tax umbrella and not a product in itself. Martin Lewis of MoneySavingExpert.com uses the helpful analogy of an ISA protecting your cash or shares in the same way that cling film protects a cake: “The tax man can no longer take a bite”. Confusion over what an ISA is means that many savers are unaware that they can shelter investments beyond these borders that could provide better returns. As Tom Stevenson of Fidelity International says, “ISAs are just a tax wrapper in which you can put any investment. They are just as useful for investing in Asia, as anywhere else”.

It is worth noting that the top seven performing UK registered ISA eligible funds over the last five years are dominated by Asian exposure. First State Greater China Growth A invests 54.98 per cent of its equity in developed Asian countries and 42.33 in emerging Asian countries. China (42.33 per cent), Taiwan (32.52 per cent) and Hong Kong (22.46 per cent) are its principal countries of investment. Other top performing funds do not invest in identical countries. For example, First State Asia Pacific Leaders A spreads itself across Hong Kong (20.63 per cent), Australia (19.78 per cent), South Korea (14.87 per cent) and Singapore (12.58 per cent); while Aberdeen Emerging Markets A Acc, although invested in Asian emerging markets (34.46 per cent) and Asian developed markets (14.09 per cent), also holds significant equities in Latin America (29.56 per cent). There is more than one way to skin a cat, but unequalled success over the last five years stems from one common factor: Asia.

This is not to suggest that investors should blindly jump into Asia without a second thought. Emerging markets are likely to suffer volatility over the short-term, particularly with the problems of weak corporate governance, political instability and natural disasters. Mark Dampier of Hargreaves & Landsdown points out that the stock market is not correlated to GDP growth. As such, some Asian markets might be overvalued, particularly in the short-term. Also, inflation across a lot of Asia and the monetary reaction could certainly hit upon the price of equities. In addition, Dampier believes that while Asia has been good, there are fund managers with a proven long-term track record investing outside of Asia, including Richard Buxton, manager of specialist UK equity portfolios and the Schroder UK Alpha Plus fund, and Neil Woodford, who runs five funds for Invesco. Just because the Office for Budget Responsibility has downgraded the 2011 GDP forecast from 2.1 per cent to 1.7 per cent, this does not mean that the UK stock market will be equally disappointing.

Picking funds solely on past performance makes no sense. Dampier says that people should always be “wary of what other people have been betting on over the years.” However, caution aside, Dampier suggests that with a long-term time horizon, Asia and emerging markets in general do still offer the potential for “far superior growth” than elsewhere. Adrian Lowcock of Bestinvest believes that with younger and higher working age populations, we should see more growth in the emerging markets of Asia. A growing middle class will have more disposable income and demand luxury goods. This view is reflected in research from Fidelity, which sees a number of trends in China pointing to “a golden age for Chinese consumption.” It argues that it is at an inflection point similar to Japan in 1969 and South Korea in 1988, so the 40 per cent of GDP currently spent on consumption in China will rise towards the US consumption rate of 70 per cent.

Top performing Asian funds are worth serious consideration. Asian countries have many problems, but as Adam Smith wrote: “there is a great deal of ruin in a nation.” Developed Asian countries are well placed to benefit from their fast growing and emerging neighbours, making for an appealing and balanced grouping. Asian markets have the potential to convert the savings under your ISA from an investment trailing inflation to one outstripping it.