David Lovell, Operations Director at GrowthInvest outlines some of the reasons behind the optimism being shown by the industry in the GrowthInvest Adviser Series currently airing six months after rule changes came into force
The dust is now beginning to settle on the regulatory changes that came out of the Patient Capital Review and which were brought into law in March 2018. The initial collective relief that the government had seemingly listened with some intelligence, and not taken a wrecking ball to a key element of a successful UK economy in the coming years, has gradually given way to a cautious optimism that the tax-efficient investment industry, can continue to impress, hold its own, and move forwards at some pace.
The Patient Capital review (PCR), and the rule changes last year, looked to refocus EIS and VCT tax breaks towards their original intentions which was to help young companies attract funding they might otherwise struggle to raise. This is the so-called “spirit of EIS”. Having raised over £18bn for UK companies, EIS has been repurposed over the years for raising huge funds into renewables, as well as less risky capital preservation strategies, where the investment itself was less of a driver than the tax break and the predictable return of the investors’ original outlay. The Patient Capital Review has resulted in a clear and fair strategy that has refocused the investment on qualifying growth companies. The government is sharing the risk alongside the investor via the tax advantages, and wants to make sure it is helping to encourage investment in the areas which can drive the UK economy forward. Indeed, certain qualifying companies which are considered to be “knowledge-intensive” have been given additional incentives, as investment limits have been raised on both sides.
Room for expansion
Whilst we will all be interested to see what happens, the exact impact of the change in regulation and removal of capital preservation schemes on the flows this year remains to be seen. It is probable that there will be at least a slight dip down from the record years £1.8bn for EIS and £700M for VCTs that we have seen over the last couple of years. The amount invested in the now outlawed “Capital Preservation” investments, which looked to lower risk to the investor by investing in areas with theoretically more stable returns such as solar panels, anaerobic digestion plants or storage facilities, has been estimated to be in the region of £0.75-£0.9 BN. This is a whopping 50% of the overall market, and certainly at least 50% of the flows from the advised marketplace. The expectation in some quarters was that a large proportion of this may simply disappear from the market, leaving the EIS industry altogether, but this seems far from the case. Many managers are reporting near record flows in the first six months of the year, even before we get into the traditional business end of the tax year – traditionally from September to April. Likewise multiple VCTs have launched in the first few weeks of September, and, at the time of writing, are seeming to benefit from decent weekly flows. They look likely to close early, recalling the rush for capacity of last year’s record £728M.
So what is driving this? For some it will be simple timing factors, and a fear of missing out on the best products, some may be the result of the long term messaging of the industry that investing in tax efficient products does not necessarily need to be left until the last minute. But there is more at play than calendar management.
Real investment returns
There is certainly an attractive investment proposition here, as real returns amongst the star performers in an EIS portfolio can commonly be double digit. We have already seen one 100 x return – including tax relief – this year, and several more headline grabbing higher exits are rumoured to be waiting in the pipeline.
Real growth opportunities are hard to find these days for a client portfolio. For the right client, a tax-advantaged, small percentage of their portfolio that takes a riskier approach should be much more common. Moreover, many clients actively enjoy learning about the investments, which are typically more tangible and transparent, with many fund managers now hosting “meet the company days” or similar. The feeling of being involved and ownership can sit alongside a feeling of supporting UK PLC, something that will be increasingly required in the coming months.
Advisers typically embrace principles of diversification across their traditional client investment portfolios. By applying the same logic to a tax efficient portfolio, they can help to mitigate the risk. EIS portfolios diversify across a group of typically 10-15 companies, but increasingly we are seeing advisers diversify further across different fund managers. They are used to advising on equity investments, and understand that these are the same products, whilst younger, riskier and less liquid.
These changes are leaving an estimated 300,000 high earners in the UK with a reduced annual pension allowance on an annual basis. Once this and the ISA allowance has been taken into account, the obvious next ports of call for tax efficient investments are the EIS and VCT markets, both of which can be an excellent addition to a retirement solution for the right clients. And this is a potentially much bigger market: there are around 2.5 million “advised clients” currently investing in the UK marketplace, and while this number will not include all of the 300,000 UK tax payers in the top 1% of earners that earn more than £160,000 income, or the estimated 600,000 or so households with more than £1 million in liquid wealth, it will certainly include a very significant percentage of them.
Capital gains on property
Advisers are reporting a significant uplift in EIS as a means of deferring capital gains on property sales. This is perceived as potentially driving a huge increase in flows over the next few years. With a generation now approaching later life that sits on significant value creation on their property assets, they will be looking to decumulate both due to their life stage and due to the unlikelihood of further capital appreciation post-Brexit and with the BOE on a tightening bias.
The guests on the GrowthInvest Adviser Hour, were cautiously optimistic throughout series one, and seem to be growing in confidence that the industry has emerged stronger than ever during the current Autumn Series two.
Whilst it’s probably a topic for a subsequent article, it is notable than none of the fund managers interviewed feel that Brexit will affect their current optimism.
The GrowthInvest Adviser Hour is a live webinar series on Thursday at 11am, and is available on demand via www.growthinvest.com. It is hosted by Lawrence Gosling, and features a panel of industry experts, including investment managers, advisers, consultants and politicians, discussing the latest news views and opinions on the EIS, VCT, and BR industries, as well as in depth interviews, Q&A and investee company insights.
David is an experienced strategic director who has worked in UK financial services for over 20 years, in a variety of distribution and consultancy roles. He joined GrowthInvest in 2016 and has been working on developing and evolving all aspects of the tax efficient investment platform’s client offering, whilst leading a growing product and development team.