There’s only a week left to use or lose this tax year’s ISA allowance. However, turbulent markets are challenging for ISA investors trying to balance growth against sheltering their portfolio from losses. So, if you’re looking for alternative investment options for your stocks and shares ISA, UK funds may well be worth considering.
Rory Bateman, head of equities at Schroders, points out that “a sizeable valuation discount has existed between the FTSE 100 and MSCI World indices for close to two decades.” While Sue Noffke from Schroders comments that “UK equities are unloved, undervalued and high yielding; an ideal scenario for stock pickers.”
I’m going to look at why UK stocks are currently out of favour. I’ll also explore the 10 best-performing UK funds over the last year for ISAs.
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Why are UK stocks trading at reduced valuations?
The valuation of UK shares has been hit by a triple whammy. The debt issues in Greece and Italy resulted in investors shunning Europe and the UK after the global financial crisis. Brexit was a further shock to stock markets, followed by the impact of the pandemic in the UK.
However, the UK is predicted to be the best-performing region in 2022, according to a recent poll conducted by the Association of Investment Companies. Investment managers from JO Hambro stated they were “utterly bemused by valuations in the UK stock market,” adding that, “rarely, if ever, have the relative attractions of the UK and our fund been brighter than this.”
The record level of mergers and acquisitions is further evidence of the relative under-valuation of UK companies. UK companies attracted substantial interest from US companies in particular in 2021, including CD&R’s purchase of Morrisons. As the New York Times put it, “Private equity firms all want the same thing: British companies.”
Due to their potential upside, I’ve invested around 25% of my ISA in UK funds. They provide a ready-made portfolio of UK shares while reducing the risk of an individual share underperforming.
What are the best-performing UK ISA funds?
UK funds can be categorised into three main sectors:
- UK All Companies (around 250 funds)
- UK Smaller Companies (50 funds)
- UK Equity Income (around 90 funds) – these funds pay an income in addition to capital growth
These are the best-performing UK funds (across all three sectors) over the last year, according to data from Trustnet:
Position |
Fund |
1-year return |
1 |
Invesco UK Opportunities (UK) Z Acc |
28% |
2 |
MI Downing UK Micro-Cap Growth B Acc |
26% |
3 |
Schroder Income Z Acc |
24% |
4 |
Vanguard FTSE UK Equity Income Index Acc GBP |
22% |
5 |
Schroder Income Maximiser Z Acc |
21% |
6 |
Invesco FTSE RAFI UK 100 UCITS ETF GBP |
21% |
7 |
UBS UK Equity Income C Acc |
21% |
8 |
Allianz UK Listed Opportunities C |
20% |
9 |
VT Munro Smart-Beta UK X Acc |
19% |
10 |
Allianz UK Listed Equity Income C Inc |
19% |
What can we learn from this list? Well, equity income funds account for half of the list, investing in large, established UK companies paying an attractive dividend income. As investor appetite has moved from growth to value shares, they have also enjoyed capital growth in share prices.
However, only one smaller company fund made the grade. Shares in smaller companies typically outperform in rising markets due to higher growth prospects, but the reverse is true in falling markets. Two tracker funds feature in the top 10, offering investors a low-fee option for their ISAs.
Which funds also achieved the highest returns for ISA investors over three years?
1. Invesco UK Opportunities
This fund delivered the highest one-year return of 28%, together with a 3-year return of 40%, according to Trustnet. It has a consistent record of delivering top-quartile returns against its peers over a five-year period as well.
Its three largest holdings are Shell, BP and BAE Systems. The rise in popularity of such defensive shares due to the cost of living squeeze may help to explain the fund’s recent growth.
2. Allianz UK Listed Opportunities
This Allianz fund is another top-quartile performer, with Trustnet reporting a three-year return of 46%. However, as with many UK funds, it made losses of 5%-8% in 2018 and 2020. It’s also focused on defensive companies, with holdings in Shell, British American Tobacco and Capital.
3. Allianz UK Listed Equity Income
This top-performing ISA fund, also from Allianz, achieved a three-year return of 41%, according to Trustnet. In addition to capital growth, it currently offers a 3.5% income yield.
The fund’s largest holdings are British American Tobacco, Imperial Brands and Shell.
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How can you invest in funds?
Using your ISA to invest in funds allows you to benefit from capital gains and tax-free income. My ISA is held with Hargreaves Lansdown, one of our top-rated ISA providers. They offer over 3,000 funds for ISAs and SIPPs.