Archive for August, 2018

Investor UK Home Bias

Posted on: August 31st, 2018 by fwAdmin

UK Home Bias

There is a tendency for investors to favour allocations to their home equity market and this can disproportionately skew investment risk within a portfolio. There are many reasons why investors adopt such an approach (some of which are compelling), but ultimately, we believe that it is important for portfolios to be globally diversified in exposures to all asset classes. The UK equity market represents only 5.6%[1] of the MSCI AC World Index by market capitalization and yet allocations within investment portfolios can often represent sizable multiples of this percentage weighting. What are the reasons for this and how can we ensure that behavioural biases do not detrimentally impact client outcomes?

Global diversification avoids the risk of portfolio returns being derailed by a country specific market/economic event (e.g. Brexit). Diversification is particularly relevant in a mature market like the UK, whereby relying on UK equities, means that you are not directly exposed to the fastest growing economies. Whilst globalisation has resulted in greater correlation within global markets, there are still opportunities to benefit from global markets that stand at differing stages of the economic/market cycle. As such, when the UK market is in a state of uncertainty around Brexit outcomes, there are other parts of the world with a more solid economic backdrop which can help to drive returns.

It could be argued that there is sufficient exposure to global economies through the FTSE 100, where more than two thirds of revenues in the underlying companies come from outside the UK. However, the make-up of the UK equity market reveals certain sector biases. By focusing on this market, portfolios end up with risk skewed towards certain industries and sectors of the economy. For example, the UK market has a heavy bias to energy and consumer staples companies. Conversely, the UK market offers less opportunity to tap into specific growth areas such as technology. The dominance of certain sectors within a portfolio can result in greater volatility.

One important consideration is currency risk. When investing in overseas equities, changes in the rates of exchange between currencies may cause investment/income values to fluctuate. It is sensible for a UK based investor (with future liabilities in sterling) to have a sizable allocation to home markets. However, for some investors with substantial UK assets (including property and UK businesses) there may be scope to tilt an investment portfolio a little further towards global markets/assets.

Whilst an allocation to global markets will improve diversification risk, one stills need to be mindful of additional risks in some regions. Of course, geopolitical risk can be a feature of all individual global markets at one time or another, but it has more frequently been a primary concern for emerging market investors and therefore we should ensure that exposure to these particular markets are sized according to the overall risk profile of the client.

So, what does this mean for Five Wealth client portfolios. We would not advocate taking a market cap approach to asset allocation. We do however believe that “home bias” should be one of the factors we consider within a holistic approach to portfolio construction and risk management. A useful reference point might be to consider how the MSCI WMA Private Investor Indices balance the allocation between UK and international equities. This provides a snapshot, reflective of the industry’s current asset allocation views across a range of multi asset portfolios.[2] Whilst our firm aims to take long term strategic asset allocation decisions, our investment committee will also form a tactical view of the prevailing risks/opportunities in various asset classes, sectors and geographies and these will feed through to the ongoing management of client portfolios.

The value of investments can fall as well as rise and you may not get back the full amount invested. Past performance is not a reliable indicator of future performance. Investing in shares should be regarded as a long term investment and should fit your overall attitude to risk and financial circumstances.



VCT’s and EIS’s – Another planning option for high earners?

Posted on: August 16th, 2018 by fwAdmin

Our previous blog in May 2018 explored the Tapered Annual Allowance and how subject to certain criteria, the annual pension allowance on which you receive tax relief may be reduced (to a minimum of £10,000) for those earning over £150,000. For those who have already managed to build up sizeable pension pots, the lifetime allowance currently stands at £1.03m (due to increase in line with inflation) and any excess over this figure will incur tax when tested that could negate the benefits of making pension contributions.

We are therefore seeing increasing numbers of clients who have maximised their pension contributions and have significant excess income with which they can look to use other allowances.

The first step would be to review your goals and ensure that any relevant ISA allowances, Junior ISA allowances or pension contributions for spouses and/or children are made. Unwrapped portfolios and other tax wrappers such as investment bonds may also meet the needs of many clients and should be considered at this point. Further details on the current tax year’s allowances can be found here

However, for those individuals who have made use of their relevant allowances and are looking for further opportunities for tax efficient investments, Venture Capital Trusts (VCT) and Enterprise Investment Schemes (EIS)/Seed Enterprise Investment Schemes (SEIS) offer some attractive headline reliefs.

These products are a government sanctioned venture capital schemes designed to encourage investment in small companies that are not listed on a recognised stock exchange. Both VCTs and EISs are considered high risk ventures and therefore are only suitable for a small number of investors.

The key difference in terms of the actual structure of the schemes is that a VCT is a listed fund, whereas an EIS scheme is not. In theory this means that VCTs are the more liquid product as you could simply sell the shares, whereas with an EIS you must wait for an exit opportunity (stock market floatation, management buy-out, trade sale etc.) to realise the investments. However, in practice VCTs can often be illiquid and trade at a discount to their net asset value (NAV).

Venture Capital Trusts (when purchased as new shares)

Enterprise Investment Schemes

Seed Enterprise Investment Schemes

SEIS’s share a lot of the same reliefs as regular EIS’s, however have some exceptions where they are more generous, reflecting the increased risk of investing in smaller companies. The main differences are:

Whilst both VCT and EIS products both benefit from 30% income tax relief, they have significantly different structures and benefits, which will need to be carefully assessed against a client’s needs and objectives. VCT’s offer tax-free income in the form of dividends which can be a useful top up to an existing income. However, the larger investment limit of £1m, Capital Gains Tax deferral, ability to set losses against income and potential BPR qualifying status of EIS can make it an attractive option. It’s therefore important to assess whether additional income, CGT planning or estate planning is more important. The products can be considered to be complementary and for some clients, a combination of EIS and VCT might be a potential solution.

As with any investment, ensuring that the underlying securities are of a suitable quality is the main priority. Changes were made to the EIS legislation in 2015, tightening the definitions of qualifying companies by introducing rules which stated EIS only applied to companies that had been trading for 7 years, amongst other. Furthermore, HMRC has recently introduced a ‘capital preservation purpose test’ which aims to weed out those schemes which are simply low-risk tax shelters and ensure that there is an actual risk to capital. It’s important to understand the legislative risk of these schemes (i.e. a company becoming non-qualifying and therefore reliefs being lost) and we would only recommend those schemes which are investing in the true spirit of the legislation by investing in genuine growth businesses.

The nature of VCT and EIS investments means that an investor will be exposed to smaller companies and therefore a higher level of risk than, for example, a fund of large cap equities. Whilst some of the risk of a drop in capital value will be offset by the initial tax reliefs, we would generally look at these products only for investors who a comfortable with the possibility of a 100% loss of the invested capital.

This blog has only briefly touched on the subject matter, VCT and in particular EIS schemes can involve some complex planning and it’s therefore essential that you seek advice before considering investing. Not all schemes are of equal quality and the experience, financial stability and diligence of the scheme/trust manager is extremely important. At Five Wealth we review the whole marketplace in order to recommend the best quality schemes. If you would like to discuss the content of this blog or would like any further information about VCT and EIS products, please contact us.

Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor. Tax relief depend on scheme maintain their qualifying HMRC structure.