Monthly Archives: March 2015

Budget Summary
March 2015

Please click here to view our summary of the key announcements in the Chancellor’s 2015 Budget statement.  We hope you will find it useful and interesting.

Unsurprisingly, the imminent General Election was one of the drivers of the 2015 Budget.  Many of the proposals will not take effect until later in 2015/16 or the following tax years.  If there is a change of government, some of them won’t survive.

Many of the measures were squarely aimed at savers.  The new personal savings allowance will be worth up to £200 a year for people with savings income – except for 45% taxpayers.  The introduction of a tax relief for peer-to-peer lending losses will please those who are in this rapidly expanding market.

There’s a special new ISA for investors who are first time home buyers and use their savings to purchase a home. The government will top up their savings by up to £3,000 on savings of up to £12,000.

There was good news and bad news for pensions. The lifetime allowance is to be cut yet again; but people will have the freedom to sell their pension annuities if they wish, though whether the protections for such sellers will be adequate is a moot point.

There was a raft of other measures and the usual crop of anti-tax avoidance proposals.

If you have any questions about the summary’s contents or how any aspects of your tax and financial planning may be affected by the Budget, please call us to discuss them.

VCTs and EIS – Is the tax tail wagging the investment dog?
March 2015

Venture Capital Trusts (VCTs) and Enterprise Investment Schemes (EIS) represent tax-advantaged opportunities to invest equity capital into very small and often very early stage – or even start-up – privately held businesses[1].   The words ‘equity’, ‘privately held’, ‘small’ and ‘early stage’ immediately point out some of the risks.

There is a certain human appeal towards potentially investing in the next Google or similar tech start-up or to own a share of a biotech firm commercialising some aspect of research for the good of mankind.  Intuitively, one knows that this is a risky, dice-rolling business and that for every winner there are bound to be some losers and some also-rans.  But the tax breaks afforded by HM Government, for both of these schemes, risk clouding the due diligence that these investments duly deserve.

It is a mistake to think that these tax breaks are altruistic in nature. Their purpose is to encourage the supply of capital to these companies in the hope that they will employ more people – who will pay income tax, make NI contributions (individual and company) and pay VAT on goods bought with their wages – and that they will generate higher corporate earnings on which corporation tax can be charged.  The tax breaks are provided to improve the risk-return relationship that potential investors in these companies face.

EIS was launched in 1993-1994, as an evolution of the Business Expansion Scheme that went before it.  Since it began, it has raised over £10.7bn for 21,000 small companies with an estimated £1 billion raised in 2013/2014 for around 2,400 companies[2]. This compares to around £22bn of retail investments into UK mutual funds[3] in the 12 months to October 2014.

The VCT scheme was first introduced in 1995.  VCTs are similar to investment trusts, raising capital by the sale of shares in the trust, which is then invested into qualifying trading companies. Total funds raised from 1995-6 to 2013-4 were £5.5 billion, with record funds raised in 2000-1 of £450 million.  In 2013-14, funds raised were £440 million, via 66 funds, out of 97 funds in existence[4].  This is around half of the funds raised for EIS in 2012/13.

Recent research[5] points out that around three quarters of advisers recommend EIS investments and over 90% of advisers stated that tax benefits were one of the main reasons why they recommended EIS to clients.  These findings are surprising – even alarming – to us.  The tax tail seems to be wagging the investment dog, particularly the fact that 70% believe these investments should be considered before other more mainstream tax breaks (ISA and pension) have been fully utilised.

The same piece of research also polled 6,000 private investors (the database of ‘Angel News’), who classified themselves as sophisticated or reasonably experienced investors; 61% held EIS investments and 93% had considered them. When choosing an investment, 92% stated that the expected level of return was one of the most important criteria.

These findings also alarm us.  Even self-selected ‘sophisticated’ investors are probably taking far higher risks than they are aware of, not least the risk of real disappointment that returns are poor (or their capital is lost entirely, before the tax breaks they receive).  Direct investment is a game of Russian roulette with a tax beak on your funeral costs!

There is a large gap between the reality of returns delivered and returns expected.  Our research indicates that only around one-in-three of existing and crystallised VCT funds managed to deliver a positive return.  It is evident that the history of VCT investing is littered with disappointment.  Public data for EIS is virtually non-existent.

The fees on EIS and VCT funds are, as one might expect, usuriously high in comparison to passive funds.  Annual management charges in the region of 2% to 3% and around 3.5% in terms of total costs[6] strip out considerable upside, and that is before any form of performance fee is deducted.  Don’t forget that there are often arrangement fees representing around 2% of each transaction.  In the end, investors only receive returns net of costs.  When costs are high, as they are in this case, intermediaries take, in our opinion, an unjustified share of the upside.  The proof of the pudding is in the eating.

The risks of VCT and EIS investments are varied and considerable, as they both invest in very small unquoted companies.  It is our belief that many investors do not have a clear insight into the risk they are taking on.  These range from the risk of failure, to owning minority stakes in illiquid private businesses and the risk of changes in the tax regime that may affect the attractiveness of the tax breaks on offer.

The conclusion that we arrive at is that it would be extremely rare for us to recommend EIS and VCT investments in the event that a client’s other tax reliefs (e.g. pension, ISA, CGT) have not yet been maximised.  These products should only be offered in very client specific circumstances where all other avenues have been explored, and only for those clients who meet stringent net worth, attitude to risk and investor sophistication criteria.

Does the tax tail wag the investment dog?  On balance, and on the evidence, yes.

 

[1]     A small number invest in AIM listed companies, but that tends to be the minority.

[2]     HMRC (2014), Enterprise Investment Scheme and Seed Enterprise Investment Scheme – Commentary Note, Released 12th December 2014

[3]     The Investment Association website: Retail sales http://www.theinvestmentassociation.org/investment-industry-information/fund-statistics

[4]     UK Government (2014), Venture Capital Trusts: Introduction to National and Official Statistics.

[5]     Intelligent Partnership (2014) AIR – Alternative Investments Report 2014, EIS Industry Report.

[6]     Merryn Somerset Webb (2014) Money for nothing among VCT managers.  Financial Times, 14th Feb 2014.

Notes and Risk Warnings

News articles are intended for educational purposes and should not be considered investment advice or an offer of any security for sale. This article is not intended as a personal recommendation of any particular security, strategy or investment product, which could only be given after consideration of individual financial circumstances and objectives. Information they contain has been obtained from sources believed to be reliable, but is not guaranteed.

Please remember that the value of investments and any income taken from them can go down as well as up. Exchange rates may also cause the value of underlying investments to fall as well as rise, and you may not get back the value of your original investment. Past performance is not indicative of future results and no representation is made that any stated results will be replicated.

Any reference to taxation is based on our understanding of the current position, which may change in the future, and articles will not be updated if tax legislation changes after their publication date. The current tax legislation affecting investments can only be considered as part of an individual advice service, as the actual tax position may be affected by individual circumstances. No reader should take any action based on the content of the publication without first obtaining personal advice from us or their own financial advisers.

Errors and omissions excepted.

 

Lessons from the FTSE 100 Record
March 2015

The FTSE 100 reached an all-time high in February, surpassing its previous peak achieved on the eve of the millennium. This illustrates that it can take a long time for the stock market to recover from a crash, but it’s not really representative of an investor’s experience since 1999. People tend to fixate on headline indices, but it’s important to understand that there’s more to a real return than the numbers that make the news.

A more realistic measure of the investment return of UK’s largest listed companies is the total return, which includes the reinvestment of dividends. By that measure, £100 would have fallen in value after the dot.com crash but would have recovered its original £100 value at the end of 2005 and since grown to £168.

The total return is more meaningful than the headline you see in the paper, but it’s still far from representing a diversified investor’s experience over the past 14 years.

Diversifying beyond the FTSE 100 might involve holding small companies that offer important diversification benefits and have a history of performing better than large companies over the long term. During this period, UK small companies more than tripled in value, so an investment in the whole UK market, measured by the FTSE All-Share, would make the £100 investment £190 over the same period.

On top of that, investing in global markets can improve expected returns and increase diversification; over this period of time, a global portfolio of shares returned £176 from the initial £100 investment.

The next time you hear that one of the world’s headline indices has risen or fallen, think hard about how meaningful this is to your broad portfolio of investments

This article was written by Dimensional Fund Advisers

Notes and Risk Warnings

News articles are intended for educational purposes and should not be considered investment advice or an offer of any security for sale. This article is not intended as a personal recommendation of any particular security, strategy or investment product, which could only be given after consideration of individual financial circumstances and objectives. Information they contain has been obtained from sources believed to be reliable, but is not guaranteed.

Please remember that the value of investments and any income taken from them can go down as well as up. Exchange rates may also cause the value of underlying investments to fall as well as rise, and you may not get back the value of your original investment. Past performance is not indicative of future results and no representation is made that any stated results will be replicated.

Any reference to taxation is based on our understanding of the current position, which may change in the future, and articles will not be updated if tax legislation changes after their publication date. The current tax legislation affecting investments can only be considered as part of an individual advice service, as the actual tax position may be affected by individual circumstances. No reader should take any action based on the content of the publication without first obtaining personal advice from us or their own financial advisers.

Errors and omissions excepted.