18 years of ISAs: what was the best performing investment company sector?

So, it’s happy birthday to the individual savings account (ISA), introduced 18 years ago next month by the then Chancellor of the Exchequer, Gordon Brown. New figures published by the Association of Investment Companies suggest many investors have reason to be grateful for Mr Brown’s initiative – the average investment company has returned 389 per cent over the past 18 years, with all those gains tax-free within an ISA.

The most interesting thing about the AIC’s statistics is the case they make for adding risk to your portfolio over the long-term. That such risk is rewarded over extended time periods is a basic tenet of investment theory, yet many investors – and even their advisers – are remarkably reluctant to embrace the idea.

The top four performing investment company sectors over the past 18 years, the AIC reveals, are all what investors would consider to be at the riskiest end of the spectrum. The outlier, the Biotechnology & Healthcare sector, with a total return of 1,313 per cent over the period, has required investors to keep the faith in a highly specialised industry and to endure substantial volatility. The next three top-performing sectors – Country Specialists: Asia Pacific; Global Emerging Markets; and Asia Pacific excluding Japan – are all variations on the developing economy theme. Again, investors have been required to hold their nerve during some very trying periods for these economies.

However, if you genuinely believe in long-term investment, the evidence of these statistics – with all the caveats about the value of past performance data – is that you will be rewarded for risk-taking if you combine it with patience and resilience.

Hold your nerve, in other words. But maybe think too about the nature of your exposure to these asset classes. Over longer periods, it has generally been the case that investment companies have tended to outperform their open-ended fund counterparts. But even leaving that outperformance aside, the very structure of an investment company makes it well-suited to investors seeking long-term exposure to riskier assets.

In each of the sectors identified, the volatility of the past 18 years has prompted enormous ebbs and flows of funds, as less long-term investors have pursued the latest hot thing or fled a seemingly collapsing market. For open-ended funds, managing these flows is an enormous distraction, particularly since these markets can often be illiquid. Meanwhile, investment company managers, with their fixed pools of assets, have been able to get on with the job of managing money.

One other thought about investment companies and ISAs. We’re sometimes told these days that the tax protections offered by the shelters aren’t especially valuable, given that everyone is entitled to both a generous capital gains tax allowance and tax-free dividends worth £5,000 a year, even outside of an ISA. Well, the AIC’s figures rather undermine such arguments, assuming you’re a long-term investor in stock market funds such as investment companies.

If you had made just a single investment of a relatively modest £5,000 18 years ago in the average investment trust, you would today be sitting on a profit of £14,445, almost £3,000 above the current CGT allowance; you’d be paying up to 20 per cent tax on all of that additional gain. As for tax-free dividends, the Chancellor’s decision in last week’s Budget to reduce the annual allowance to only £2,000, just a year after it was introduced, is another reminder that it’s never sensible to base your financial planning on the assumption that the government won’t change the rules.