Low yields and uncertainty around Brexit means interest in business relief is increasing, says Jack Rose, Head of Tax Products at LGBR Capital.
With interest rates at record lows and forecast to remain below 2.5% for over seven years, today’s low yield environment continues to be the ‘new normal’ for investors and presents a significant challenge for income seekers. The UK’s decision to opt for Brexit (whatever that ends up meaning) has also seen volatility return to mainstream asset classes, equities and FX in particular.
Low yield environment continues to be the ‘new normal’
Source: British pound swaps curve projection – Bloomberg 16/09/16
This has been the backdrop to an increased interest in products using business relief (BR), many of which aim to provide capital preservation and attractive levels of regular income alongside their primary focus of inheritance tax (IHT) mitigation for investors. In conjunction with HMRC’s IHT receipts for the 2015/16 tax year hitting an all-time high of £4.6 billion (with an increase to c.£5 billion forecast for the current tax year) the demand for IHT products looks set to continue to grow.
Business relief is not a new piece of legislation (it was introduced in the 1970s) but it is only relatively recently – in the past 10 years or so – that it has grown in popularity with advisers and investors.
Historically advisers tended to rank BR solutions behind more traditional estate planning options such as trusts. However, as trust rules have become ever more complex BR has continued to grow in popularity as the greying population demands more dynamic and flexible estate planning options.
The benefits of BR relating to its speed (only two years before IHT mitigation), control and flexibility (investors own the underlying asset) are well known. Less well known are advantages such as replacement relief that allows investors to move from one BR qualifying asset to another without restarting the two year IHT exemption clock, so long as they have held shares in any BR qualifying asset for two of the last five years, which is a real advantage for business owners.
Another is the ability for advisers to utilise BR in cases involving Power of Attorney. As awareness of these ‘additional’ benefits has increased, so has the profile and popularity of BR focussed solutions.
Correspondingly the market for BR products offered by investment managers has seen a dramatic expansion, with over sixty different options now available and several managers with track records of more than 10 years.
IHT strategies that utilise BR can, at a basic level, be divided into two buckets;
- those that invest in a portfolio of AIM stocks – seeking growth and income whilst also qualifying for ISA investment
- and those that specialise in alternative asset backed strategies, focusing on capital preservation
Here we will focus on the latter bucket, as these investment strategies can provide attractive levels of regular income with low correlation to traditional asset classes, as we mentioned at the top of the article. Investing in AIM stocks can also provide the opportunity for long term capital growth and income – but it does, as you would expect, have a high correlation to equity markets and therefore comes with a level of associated volatility.
Preserving capital
Most capital preservation IHT products are usually structured as discretionary managed services, in which investors are allocated shares in one or more underlying, investee companies. It is these companies which qualify for BR and in which the investor holds shares. Some qualifying investee companies use an LLP or LP structure but these are less frequent and are predominantly used for corporate investors.
When comparing providers, although the overall structure may look very similar, one key point of difference is the underlying investment strategies and sector focus. Obviously it is extremely important to understand the specific underlying sector or nature of the investee company’s business, because this, like any business, carries its own opportunities and threats, which investors need to be aware of and be comfortable with.
There is a plethora of different sectors available for investment, from renewable energy, secured leasing/financing, property lending to media and many more. Potential target returns also vary from cash plus to equity-like returns, although the majority of products offer returns in the range of 3-6% alongside capital protection. With the Bank of England’s base rate at 0.25%, you can see the attraction.
As the IHT product space grows and matures, there is now an increasing number of product providers who can demonstrate track records of delivering these returns across multiple market cycles. Of course it goes without saying that any past performance is certainly no guarantee to future performance.
The below graph provides a good illustration of these steady uncorrelated returns against wider equity markets:
Belinda Thomas, Director of Triple Point Investment Partners, which has specialised in IHT products since 2006 agrees: “BR qualifying investments are increasingly becoming more mainstream, as a complementary addition to a client’s existing portfolio, given that their returns tend to be uncorrelated to the traditional asset classes.”
Choosing the right solution
So how should investors and advisers choose between the sixty or so different options available in the market? All the points previously mentioned are important areas to consider, such as such as track record, returns (after fees) and the underlying investee company. But there are others such as liquidity, size of the offering, the pedigree and expertise of the investment team.
For investors keen to research the market there are a number of independent sources that offer due diligence and research such as; The Tax Shelter Report, The Tax Efficient Review and MiCap. As with most investments a diversified approach is a prudent way to manage some of the risks, not just utilising different providers but more importantly diversifying by underlying trade or business sector of the investee companies.
The last aspect to consider is accessibility. Many of these solutions are structured as discretionary managed services that invest in one or a small number of unquoted businesses, which means the risk profile will not be suitable for all investors. For advisers recommending these types of strategies for clients there are also considerations around PI and compliance. Also, they are also not available on mainstream platforms which increases accessibility issues.
In conclusion, the benefits of BR strategies such as speed of IHT mitigation, control for the investor in directly owning the underlying asset, replacement relief and Power of Attorney make them useful tax-planning products. However, whilst not without risk, these products can also provide an attractive yield in today’s low income environment alongside their capital preservation objective which widens investor benefits beyond the obvious need for estate planning– as long as investors have assessed the important considerations such as diversification, the business sector and the expertise of the provider’s investment team.
