Sunday 29 June 2014 11:15 pm

The new Isa: Where to invest your beefed-up Nisa allowance

The fund managers are tipping European equities and a focus on long-term capital growth through income

With the new Isa (Nisa) annual allowance of £15,000 (up from £11,880 for stocks and shares Isas) due to come into force tomorrow, savers looking to top-up their investments are faced with a difficult choice. The popular play of the last few years, betting on the UK recovery through small and mid-caps, looks like it may have run its course. The small-cap Aim market is now down 8.45 per cent since the start of the year, while the mid-cap FTSE 250 has fallen by 1.53 per cent, a far cry from the double-digit growth experienced by both last year.

Meanwhile, a combination of geopolitical flare-ups, the prospect of tighter monetary policy in the not-too-distant future, high valuations and eerily low volatility have raised fears of a correction on major equity markets. As of last week, the S&P 500 index hadn’t budged by more than 1 per cent for the longest period in over 20 years, while the Dow Jones and FTSE 100 have stayed close to all-time highs for some weeks. Many wonder how much longer the good news can last.

But there are some promising investment themes raising their heads, with dividend income and the prospect of earnings growth in European equity markets proving particularly popular. And focusing on the prospects for long-term capital growth in these areas will allow investors to make the most of the beefed-up Nisa.

After years of underperformance, European corporate earnings are set to “start to surprise on the upside again”, according to Jonathan Ingram of JP Morgan Asset Management. The automotive sector in particular, he argues, looks set to benefit from an improving macroeconomic backdrop and rising demand, with BMW experiencing a 7 per cent year-on-year rise in car sales in March. Auto component companies, he says, are likely to see a similar uptick in demand.

Jason Hollands of Bestinvest is similarly upbeat on European equities. “Europe remains our a favoured developed equity market, based on valuation compared to the US, and because the European Central Bank (ECB) is being drawn into more accommodative policies to address the risk of deflation.” To gain from any improvement in the European economic situation, Hollands favours smaller companies whose earnings are mainly drawn domestically. Baring’s Europe Select Fund has exposure to these firms, while he also likes Threadneedle European Select Opportunities and Henderson’s European Focus Fund.

In the UK, on the other hand, investors may need to be more selective. The feeling among some fund managers is that the good news from the UK’s economic recovery is now largely “priced-in”: just betting on smaller firms to ride the tide of improving sentiment might not be as profitable in the future. Tony Lanning, manager of JP Morgan’s Fusion Funds range, argues that the property sector (particularly outside the capital) looks promising. “A common belief has been that only London has driven the increase, but since the latter half of 2013, there are signs that the recovery has been  broadening.” His prefered way of gaining exposure is through the M&G Property Portfolio, which has a decent exposure to commercial property.

Investors nervous about a potential stock market correction, however, may want to consider a more defensive equity income fund, says Richard Troue of Hargreaves Lansdown. “Trojan Income, for example, aims to grow capital and income over the long term, but also preserve some capital if markets fall.” It’s also wise to think about not throwing the whole allowance into overstretched markets at once, only to see your capital battered by a stock market storm, argues Rebecca O’Keeffe, head of investment at Interactive Investor. One option is to make use of the cash park facility available through most investment Isas, she says. Investors can then drip-feed money into the markets, reducing the chance of capital falling in value all at once.