Investors are facing one of the shakiest starts to the annual Isa season for years.

The Bank of England gave its bleakest assessment of the UK economy for 10 years last week, the FTSE 100 index of leading companies is down 9% since January, and banks are set to write off millions of pounds in bad debts in the coming month.

All this comes as thousands of people are preparing to invest their £7,000 Isa allowance before the end of the tax year on April 5. They will be understandably nervous about ploughing the money into equities in such volatile times.

With this in mind, we invited several leading fund managers to discuss the outlook for the markets. The resulting discussion was one of the most polarised we have hosted. On one hand, Tim Steer of John Duffield’s New Star Asset Management and Mark Lyttleton of Blackrock Merrill Lynch predicted UK shares would suffer their first negative year since 2002.

On the other, Richard Buxton of Schroders was confident that stock-market investors would bank double-digit returns from shares this year. “2007 was the year you made no money from equities, not 2008,” he said.

Cash beat all the main assets, including shares, after inflation last year for the first time since 2001, according to last week’s Barclays Equity Gilt study.

However, most of our guests agreed that if you are investing with a three- to five-year view, you should still put your money in equities. Nervous investors could “phase” their Isa money into the markets over several months in case prices fall in the short term (see panel, right). Here, we present their views.

Kathryn Cooper, Money editor: Can Isa investors count on things getting better, or is there worse to come?

Tim Steer, New Star: I don’t think we have seen the worst of it, although we can only answer that question after the results from the banks over the next month or so. I should imagine auditors are having huge, huge issues signing off the balance sheets of these banks. Accountants will be quivering in their boots and thinking perhaps there’s another Arthur Andersen around the corner.

It’s far too early to talk about the bottom or the trough until those bank results are out of the way. There will be writedowns, but who knows how big they will be. Banks started off by marking things to market [valuing their bad debts according to a market price], now we’re marking things to model [valuing bad debts according to a “modelled” price] and next, we’re going to be marking things to make it up.

Mark Lyttleton, Blackrock Merrill Lynch: The UK and European banks put out some trading statements in November and talked about writedowns and since then there has been complete radio silence. The world has moved a long way in the past three or four months and they are either incredibly well run, or you are going to get some more problems coming out. The question is how much of that is already reflected in share prices – it’s a difficult call.

Richard Buxton, Schroders: That said, if they had needed to write down more, they would have had to say so.

Steer: Well, they may not know how much they have got to write down yet. Markets are moving an awful lot. As an ex-auditor, I would say many valuations are quite subjective.

Graham Ashby, Credit Suisse: My concern is that this is a 2008-9 issue that is only becoming apparent for some of these banks. At the very least, you are going to have no or very little dividend growth, and, at worst, dividend cuts and big capital raising.

Rekha Sharma, JP Morgan: This process of banks gearing up their balance sheets has taken a very long time; it’s not about to be unwound very quickly. Earnings forecasts for 2008 are still really rich. Everyone is betting on a recovery in the third and fourth quarters, but I think there is a lot more to come. We have had unprecedented growth, it’s been great, we’ve all been quite spoilt, but I think the chickens are coming home to roost.

Buxton: I’m finding this discussion fascinating; I’m buying banks right now on the basis that they could rally substantially. I don’t think that the market’s fears of substantial write-offs, capital raising or dividend cuts among the larger UK banks will prove valid in the short term. Royal Bank of Scotland wasn’t in the portfolio six months ago, but we have been buying it as well as adding to Barclays and Standard Chartered ahead of their results.

Lyttleton: Are you playing on the fact that everyone is so down-beat on the sector – listen to us all being really grumpy and miserable – but quite a lot of that’s reflected in share prices already.

Buxton: When you see stocks paying 7% or 8%, the likelihood is that you will get a good return.

Steer: But Richard, when you see a stock on a 7% or 8% yield, if you look at the history of it, how often does that company pay that dividend? The market is telling you something.

Gary Potter, Thames River: My concern is the impact of tighter lending by the banks on the overall economy and on ordinary consumers.

You are certainly finding that the average person’s real inflation rate is a lot higher than the core rate, and overall the consumer side of the economy looks to be facing a fairly tough year.

Steer: We’ve talked about the banks, about their balance sheets shrinking, which means there will be less credit around for consumers and for property companies.

It’s a big domino effect and although we are running UK funds, we should be looking beyond the UK economy. My portfolio must be 70% to 80% in activities outside the UK.

Cooper: So not a good time to invest your Isa in UK equities – or is it?

Buxton: The key thing for people thinking about their Isa is: do you think the market is going to come down another 50%, in which case you want to avoid the market like the plague. Or given that a lot of shares have halved already, is this the time to invest?

Last year was the year you made no money in equities and this is not the time for people to be scared. There is an awful lot of bad news in share prices and if you’re investing with a two- or three-year time horizon, it could be the perfect time to invest.

Ashby: It doesn’t look like there is going to be much of an Isa season. And being a contrarian about it, that’s the time to invest. Although economically the news is going to remain pretty poor, I actually feel pretty confident about the market.

Lyttleton: I would definitely put money in an Isa, but you will get a better opportunity to invest in the UK market and emerging markets or commodities in the next three to six months. We are going to get another period where people get significantly worried about growth and valuation and the financial system.

Buxton: Markets are similar to the beginning of 2003 when things were going down day in and day out because the life companies were selling, and the hedge funds compounded that. You were buying things that you knew were cheap where the business was good, but it was getting cheaper day in and day out. That’s the parallel. And March 12, 2003, was time to buy.

If, like most people, you buy in the last week of the tax year it will be the time to buy in retrospect.

Lyttleton: So you think the financial crisis will be resolved in four to six weeks?

Buxton: No, but I think the end will be in sight.

Cooper: Will we have a negative year for equities?

Lyttleton: I think we will have a down year, yes.

Steer: So do I.

Lyttleton: But not much; we’re 10% down already.

Buxton: Shares will be up – returns could be in the double digits. People are positioning themselves defensively, which is a good sign for the markets.

Potter: I would say we could go lower before the end of the year. But I don’t think the market will go below 5,000.

Buxton: Yes, that would mean equities would be yielding significantly more than gilts, which would be a buy signal.

Steer: Provided the banks pay dividends.

Potter: There is a huge lack of visibility, and we have reduced our equity exposure over the last few weeks. I think things will go lower before we even have an idea. You need central banks to come in more actively. We have been holding the money in cash and I think a lot of managers have been doing the same – cash positions are at extremes.

Buxton: A classic contrarian signal to buy.

Sharma: Perhaps, but I think there will be better buying opportunities. We are looking for opportunities to buy into bonds.

Potter: To buy bonds at this level, you have to believe there will be a major and sustainable economic recession.

Lyttleton: Over the next three to six months I would put my money in my short fund.

Steer: I would put mine in my institutional short fund, too.

Cooper: Given your caution, if you were an investor with a balanced portfolio and a long-term view, where would you put your Isa money?

Lyttleton: I would still go into UK equities but I would defend myself with a bit of gold, or commodities.

Steer: Yes, UK equities with a bit of international exposure. The mining sector for a start, and oils. The UK and North America are having a tough time, but the Middle East, the Far East and China don’t appear to be and they need commodities. When you’ve got growth in China of nearly 9% and very little growth in the UK and the US, it seems entirely sensible to me to invest in that kind of growth and one way you can do that is to buy the mining sector. Commodity prices are rising, there is a shortage of certain minerals and resources like copper, supply is constrained. I like companies such as Cookson, which supplies the jewellery industry with precious metals, and Weir Group, which supplies the mining industry.

Lyttleton: While I am pretty optimistic about the mining sector on a three-year view, you can see it is a volatile sector and there are periods when it can fall 20% to 30% in the space of weeks.

Ashby: We shouldn’t forget we have some fantastic companies in the UK whose shares are down considerably, trading at interesting valuations. Companies where you have faith in balance sheets and good management. Take hedge fund manager Man Group, which in the autumn committed to return a lot of cash to shareholders.

And there are plenty of very good industrial companies – just because we aren’t a leading industrial nation anymore doesn’t mean there aren’t good companies. Take Ultra Electronics, probably one of the best aero-space and defence firms. And we’ve strong niche retailers like Ted Baker. You don’t have to own BP and Glaxo Smith Kline.

Potter: The small and mid-cap stocks have been pummelled so much, that some of these businesses, relative to their larger brethren, might be interesting. There are some excellent managers in this space with outstanding track records, none more so than the team at Old Mutual under the guidance of Ashton Bradbury.

Lyttleton: I think the property companies are more interesting now than they have been. I think in the UK we are going to havea short sharp correction in valuations and we may be over halfway through that. We have bought real estate, such as Hammerson, but there is no rush as valuations have further to fall.

Buxton: Unfortunately, it is too late to sell your commercial-property fund, but too early to buy.

Potter: I think the emerging markets and Asia will come out of this in a stronger position. They are sound – as long as you find managers who invest sensibly. First State has a good pedigree in this area. And Russia looks interesting – Neptune Russia could be a good bet.

I would be concerned about buying corporate bonds at this level because the default risk could rise. North America might well surprise investors on the upside and investors might even enjoy a better time for the US dollar versus sterling. Martin Currie’s North American fund is worth a look.

PUT IN YOUR MONEY BIT BY BIT

Savers who want to invest their full Isa allowance before the end of the tax year but are concerned that shares could fall in the short term, should consider ‘phasing’.

Several investment firms and fund supermarkets, including Fidelity, offer a phasing option, where your money is gradually invested over a number of months. If the stock market drops, you can then buy more shares at lower prices.

Say you want to invest your full Isa allowance of £7,000 in an equity fund before the end of the tax year, but do not want all the money to go into the market straight away. Your lump sum might be split into six equal amounts. The first £1,166.67 would be invested immediately and the rest in five equal amounts over the next five months.

As long as you buy the phased investment before April 5, it will still count towards this year’s Isa allowance.

Fidelity Funds Network has also launched the Cash Park Isa for cautious savers. This allows you to secure your full £7,000 allowance without immediately committing the money to equity or bond funds.

As long as you intend to invest the money at some point in the future, the Revenue is happy for you to keep the money in cash.

The Cash Park fund pays a gross rate of 4.85%, although the Revenue insists that cash held in investment Isas is taxed at 20%, so interest is paid net.

David Dalton-Brown, head of Fidelity Funds Network, said: “Isa investors who are nervous about the stock market after January’s turbulence no longer have to lose this year’s tax breaks. Instead, they will be able to temporarily place their money in cash before the 5 April deadline and then invest into funds at a later date.

“When investors decide the time is right to invest, they can then switch their money to any of the 1,100 funds on the Funds Network platform.”