What makes an investment company suitable for an ISA?

With less than two months to go until the end of the tax year on 5 April, financial services companies are ramping up their marketing efforts. They do the same at this point in the calendar every year and the message is consistent: use your individual savings account (ISA) allowance before you lose it.

In the 2014-15 tax year, however, the message has even more resonance because ISAs are now more generous than ever before – they now allow you to shelter up to £15,000 worth of assets from tax, a significant increase on last year’s allowance of £11,520, and the range of investments you may put inside an ISA wrapper has never been wider.

Still, that presents its own problems: with so much choice (and so much marketing) how do you decide where to put your money? The answer of course, is that the right ISA solution depends on your individual circumstances, but there is certainly a very strong case to make for the investment company sector – closed-ended funds have certain characteristics that make them particularly well-suited to ISA investment.

The first of these is the strong record of closed-ended funds when it comes to dividend income. The income tax advantages of ISAs are sometimes underestimated, as basic rate taxpayers do not benefit from receiving dividends in the ISA. Higher-rate taxpayers will still benefit, however, and the consistent performance of investment companies on paying dividends makes it especially important to protect this income – some 35 funds have raised their dividends each year for the past decade, while a good number have records of doing so that go back three or even four decades.

When it comes to capital profits – which are completely tax-free with an ISA – investment companies have a strong record too. Naturally, investment performance varies from fund to fund, but the sector has certain advantages. Investment companies are allowed to take on gearing – they can borrow to invest, which soups up returns when asset prices are rising.

The other advantages of closed-ended funds concern structure and governance. On the first point, the fact that an investment company has a fixed size means its manager doesn’t have to worry about inflows and outflows of cash when thinking about where to invest the money, which can be a major distraction.

On governance, meanwhile, it’s important to understand that closed-ended funds are companies like any other – they have boards that include independent directors whose role it is to ensure shareholders’ interests are properly looked after. This isn’t simply a theoretical duty, as is illustrated by the case of British Assets, set up 188 years ago but still innovating today. The fund’s board has just asked shareholders for permission to shake up the trust in order, hopefully, to refresh performance – current fund manager Foreign & Colonial is to be replaced by BlackRock, and the fund is to completely change where and how it invests.

Armed with advantages on gearing, structure and governance, investment companies, at least in the past, have tended to deliver superior investment performance. On average, they’ve beaten their open-ended fund equivalents across most sectors of the market over most timeframes.

Hence the case for considering investment companies for your ISA. The shelters enable you to keep income and capital profits out of the reach of the taxman, so it makes sense to use them to hold the investments that produce more of those returns. Enter the closed-ended fund.