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Depressed markets make this a bad time to be in equities – but potentially a good time to get into undervalued stock, which coincides with new ISA rules. David Burrows looks for silver linings

Not long ago the whole future of ISAs was in question. Gordon Brown (then chancellor) was reluctant to commit long term to ISAs, but once he did things moved on apace, and the recent changes to ISA rules could prove of enormous benefit to equity investors.

From 6 April 2008, all existing Pep accounts will become stocks and shares ISAs. This is a great opportunity to review old and perhaps redundant Peps. Holders will be able to view all their Pep and ISA investments on one statement and to devise a strategy for them. This is a particular benefit to actively trading self-select ISA investors.

The last budget also provided the freedom to transfer cash ISAs into equity ISAs. For one investor this could now amount to £30,000 cash (including interest) available to invest in the stock market tax-free.

It may not seem timely to move from cash to equities when there is a reluctance to take on unnecessary risk. Stockbrokers have reported that, in 2007, money market funds accounted for 39% of assets invested. But depressed valuations mean stockpicking opportunities.

Stephen Adams of Aegon Asset Management believes ‘some very interesting opportunities are opening up. We are even starting to look at financials again. I think UK banks have to recapitalise before they start to look interesting. But stocks such as Standard Chartered, largely unaffected by the sub-prime fall out, look attractive and Man Group in the alternative investment space continues to interest us greatly.’

Karen Garner at TD Waterhouse expects a healthy appetite for switches from cash to equities when the facility begins in April. ‘The fact that the option is there is great news for investors. Some no doubt will put this cash into direct equities, others in this volatility might temporarily prefer the safer option of collective funds. For instance, we are seeing a great deal of interest in commodity funds and China funds – our biggest sellers are the BlackRock (formerly Merrill Lynch) Gold & General fund and the Gartmore China Opportunities fund.’

Malcolm Cuthbert, managing director of financial planning at Killik believes the move to equities could be gradual. ‘I expect to see investors moving from cash ISAs into gilts and bonds and from there into equities when they feel the time is right. I think you also have to remember that self-select ISA investors can invest in international shares too so they can avoid US and UK markets and be more global.’

Tony Celentano, manager at E*TRADE UK, suggests ISA investors will tread cautiously initially. ‘Even with cash suddenly available for equity ISAs, I would expect investors to follow the current trend of looking for inflation hedges such as commodities. Also we will no doubt see further ETF investment as they are less sensitive to stock market fluctuations.’

He adds: ‘Investors are actively looking into trading ETF’s as more become available on the market. This gives them the opportunity to trade gold and other commodities, which they could not do previously.’

One inhibiting factor could be that ISA investors can move from cash to equities but not from equities to cash, except in the very short term, as Cuthbert explains. ‘Cash may be held temporarily but only with the intent to invest it in qualifying investments and not as a kind of tax-sheltered cash deposit. This is why HMRC charges a 20% flat rate on all interest earned in an equity ISA. It makes cash deposits less attractive in the equity ISA. But if equities look treacherous and interest rates are heading down, it could be worth moving money from your cash ISA to high-yielding bonds in an equities ISA.’

Self-select ISAs are not for all – much depends on the frequency of your trading and your tax position. As with a traditional equity ISA, any gain will be free from capital gains tax (CGT). Dividends earned by the shares in the wrapper are taxed at 10%, unlike the 32.5% higher-rate taxpayers would normally pay. While this is worth £22.50 for every £100 of dividends for higher-rate taxpayers, it has no direct benefit for those in the basic rate band as they would pay the same rate, 10%, outside the ISA wrapper. So unless basic-rate taxpayers expect their shares to present them with a CGT bill – say for example, they are planning to cash in their investments and make a profit exceeding £9,200 in a year – there would not be great benefit in holding shares within a self-select ISA.

Privileges for frequent traders

The flexibility to buy and sell when you want, rather than at a fund manager’s discretion, also suits self-select ISAs to more frequent traders, and for someone trading 30 times or more every quarter with E*TRADE, commission will go from £8.95 to £6.95. The trader then becomes a Power E*TRADE client and receives Power E*TRADE market trader, a research tool with streaming, real-time watch lists and market data, advanced real-time charts with technical indicators, advanced real-time company and market news and streaming Level II. E*TRADE will charge up to £4.85 a month if there are less than two trades within a six month period, while Barclays charges £9 a quarter. You need to weigh up all the costs, which could also include fees for transferring stocks out of the ISA and when you want to close the ISA. E*TRADE’s transfer out fee is £15 plus VAT per stock. Providers will not charge you for transferring in. But will a new ISA provider cover these costs to win your business? Killik & Co will pay all Pep and ISA transfer costs and there is no inactivity fee.

Those only interested in funds are better off with a fund supermarket, but for mixing and matching your own handpicked stocks with other products, a self-select ISA is ideal – especially when brokers compete for business.

‘You have to shop around,’ Garner explains: ‘We have negotiated discounted deals with fund houses such as Gartmore, so there is 0% initial sales charge, and a range of annual management charges on its fund range from 0%-2% for the Gartmore UK Index fund. For instance, the AMC is just 0.5%.We are currently negotiating with BlackRock to offer similar deals. At TDW for those investing sums over £3,600 there are no admin fees, (usually £30) This is available indefinitely.’

Better deals are mostly available to those investing larger sums. For instance, The Share Centre is offering free shares in its parent company Share (trading on Aim in March 2008) to those investing the maximum £7,000 a year in an equity ISA or those transferring Peps or ISAs of an equivalent value.

It is also worth noting that from this April the government has raised the amount you can subscribe to an ISA from the current £7,000 to £7,200 for an equity ISA and £3,600 for a Cash ISA.