Wealthy Clients Need Different Strategies

by | Nov 13, 2013

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Investment Strategies For the Well-Heeled Investor Can Look Quite Different, Says Kam Patel


It isn’t every day that we discuss the specific needs of wealthier investors in these pages. And you can probably blame the regulators for that. Unsurprisingly, in this post-Lehman, post-Arch Cru, post-meltdown era, all the regulator’s attention has been on protecting the weak and vulnerable from getting into things they don’t understand, or things that might harm them. And the media has inevitably followed.



That’s good. And by the same token, the experienced investor – loosely defined by government as someone with £250,000 in his portfolio and/or £100,000 a year of income – is generally reckoned to be able to fight his own battles and take his own risks. And although we might decide to make a few exceptions for ‘vulnerable’ millionaires such as the recipients of large insurance payouts or possibly lottery winners, the consensus is still that a wealthy investor is able to take risks that would be inadvisable for the ordinary retail investor.


That doesn’t necessarily mean, of course, that all the remaining wealthy clients are financially sophisticated, or that they will understand the true nature of the risks being undertaken. And risk, as Warren Buffett has sagely observed, “comes from not knowing what you are doing”.



So, for wealthier, financially independent investors, a detailed assessment of their risk tolerance is where it starts, just the same as usual. Along with ensuring that they have a clear understanding of the products being considered, including their regulatory status, and the role that such investments will play as part of a broader wealth strategy. Once these key factors have been addressed, a number of alternative high risk-high return investment strategies offer themselves up for consideration. 



Ucis – Suitable For Some

And so to the first and the most current of these strategies. Unregulated collective investment schemes are schemes in which a number of investors pool their money to invest in one or more assets. Examples of Ucis may include investment in property, fine wines, renewable energy or gemstones. Although Ucis funds are not directly regulated by the FCA, UK domiciled funds do require an FSA regulated operator.


As you’ll have noticed, it’s been a tough time recently for Ucis providers. The FCA and its predecessor have been clamping down hard on their promotion – not so much because of the risk but because of concerns that they were being promoted to customers who were wholly unsuitable. And because so-called ‘Ucis-like products’ were also being devised that looked and behaved like Ucis funds even though they were technically described as something else.


On 4th June the FCA announced a massive tightening of the rules on promotion of Ucis and Ucis-like products (jointly known as Non-Mainstream Pooled Investments (NMPIs). Under the new rules (Restrictions on the Retail Distribution of Unregulated Collective Investment Schemes and Close Substitutes, Policy Statement  PS 13/03), their promotion is restricted, within the retail arena, to sophisticated and high-net worth individuals with an income of at least £100,000 or net investible assets of more than £250,000.


In some ways that wasn’t such a surprise. The former Financial Services Authority (FSA) had found that only one in every four advised sales of UCIS to retail customers was suitable, and that many promotions had breached the existing UCIS marketing restrictions pretty badly. More surprising, and something of a relief, was that Venture Capital Trusts and Enterprise Initiative Schemes that are not structured as Ucis vehicles were left outside the scope of the ban.


The good news is that the FCA is allowing firms until the end of 2013 to implement the new rules. The bad news is that it is telling investors who already hold a NMPI to seek advice on whether it’s still suitable for their needs. In the meantime, it says, firms affected by the new rules should use this interval to consider what changes, if any, they need to make to their systems, and to make sure they are ready to follow the new rules when they come fully into force.


Sure enough, the crop of bad Ucis apples is still falling off the trees. Last month for instance, it emerged that 18 investors are pushing for legal action against advice firm Omni Executive after it gave them ‘unsuitable’ advice to invest around £30 million in film, property and carbon dating Ucis funds. And wealth manager Helm Godfrey also revealed that it is under regulatory investigation for various sales of unregulated collective investment schemes between 2007 and 2010.


Indeed, some observers have argued that there should be a complete ban on Ucis at the product level.  All of which has caused some consternation in the industry. Joe McTaggart, managing director of Walls & Futures, an asset manager with a focus on property, is one who believes the criticism of Ucis is not entirely justified. He argues that, in the main, Ucis vehicles do offer investors access to alternative investment opportunities that both complement and balance their portfolios.


 “They are useful when investing in illiquid assets such as property,” says McTaggart, “as we saw at the height of the credit crisis, when investors were jumping ship from perfectly good property investments, which forced the asset managers to sell at significantly reduced prices in order to create liquidity. That in turn lost money for investors who wanted to keep the investment.”


“Unfortunately,” he adds, “there have been a few bad apples where both the asset class and the governance of the scheme were rotten.” Apart from failing to deliver returns, some schemes, he says, had “very poor or non-existent exit strategies and fundamentally very weak corporate governance.”


Walls & Futures’ own offerings are focused on offering investors the opportunity to generate un-correlated returns by investing in a portfolio of residential property in Central and South West London. The strategy, says McTaggart, is to generate returns by developing or renovating properties which are then let to create an income stream. Capital growth boosts the performance, but the provider is not solely reliant on the market to deliver the returns.


Points To Watch, Questions To Ask

Commenting on best practice for the management of Ucis vehicles McTaggart stresses that first and foremost issue to address is corporate governance:  “It is important to have checks and balances within the fund to ensure there is a third party ensuring the asset manager does not stray from what has been said in the information memorandum. Corporate governance is possibly the most important matter to look very closely into with regard to safety.”


McTaggart says that IFAs need to firstly understand that Ucis is like a SIPP type of investment vehicle. Therefore advisers need to focus on what is inside, rather than the wrapping:  in the case of a property fund, for instance, the location of the holdings can be paramount.


Another key question that an adviser needs to ask when assessing the quality of a vehicle is how the fund intends to make its money Will the returns be based on one action – for example, capital growth? Or does it have a variety of methods of generating returns?  How does the asset manager’s experience in the sector stack up?


The big advantage of Ucis vehicles, McTaggart says, is their ability to invest in asset classes that regulated funds cannot, and their access to higher risk strategies and therefore potentially higher returns. But conversely, Ucis vehicles require more time and effort on research and perhaps a higher level of due diligence.



The government-backed Enterprise Initiative Scheme is another prominent vehicle for consideration by the wealthier client. The scheme is designed to encourage investments in small unquoted companies, for instance film companies. The quid pro quo for their illiquidity is that investors can benefit from very generous tax breaks. 


Provided underlying investments are held for at least three years the income tax relief an individual can claim on EIS investments is 30%, with an investment limit of £1m per tax year.

Other key EIS benefits include capital gains tax deferral; 100% inheritance tax relief (provided funds remain invested at the time of death); and up to 50% loss relief on any holding that falls in value.


Once again, due diligence is critical: there has been considerable concern that EIS vehicles were being constructed purely to avoid tax. Last year HM Revenue & Customs won a landmark case against a film-financing scheme called Eclipse 35. HMRC accused the scheme, conceived by Future Capital Partners, an alternative investments specialist, of being little more than a tax avoidance vehicle, that it was not a genuinely trading concern.


It is important that investors are aware of the rules EIS companies have to observe, not just at the time of the investment but for at least three years afterwards. If an EIS company fails to stick those rules, tax relief will not be given, or, if it has already been given, will be withdrawn by HMRC. Similarly, it is important that companies appreciate the conditions to be met by investors, so that shares are not issued on which the investor expects to be able to claim tax relief, only to find that no relief is due.


Place Your Bets

And so to one of the further reaches of the adviser’s repertoire. Spread betting and contracts for difference have acquired a certain notoriety in some quarters because of the ease with which they can wipe out a portfolio. They are-after all, leveraged products. And yet, in the right hands, they can both offer a convenient and tax-efficient alternative to trackers and ETFs. You can spread-bet practically anything – currencies, bonds, companies, commodities, either up or down.


The key difference between the two products is in how they are priced. With spread bets, there is no commission and any charges will be included within the spread. CFD prices, on the other hand, will usually mirror the underlying market, and a commission is charged separately by the broker for carrying out the trade. Of the two, spread betting is the more popular within the UK.


Christopher Roff, senior sales trader at Plutus Markets, says that a key advantage of CFDs and spread bets is that they allow investors to leverage their returns: “Trading shares in the traditional manner requires the investor paying the full purchase price – but, by using either of these instruments, it is possible to create the same exposure with a smaller capital outlay.


“With either product you can hold both long and short positions, giving the investor the opportunity to benefit from both rising and falling markets. The margin requirements are similar, but the initial deposit required to open a spread bet tends to be smaller than that for a CFD. Additionally, the minimum stake size of a spread bet is generally lower than the minimum deal size of a CFD.”


Both CFDs and spread bets are exempt from stamp duty, which makes them especially suitable for clients who trade more actively and who may hold positions on a short-term basis. “Any profits made from spread betting are tax free under current UK tax legislation,” he says. “CFDs are not capital gains tax exempt, but any losses can be offset against profits for tax purposes.”


As you’d expect, another plus with both CFDs and spread bets is the ability to go short. “A portfolio can be hedged during unpredictable times by selling exposure to major market indices like the FTSE 100. Both products allow clients to manage their risk by allowing “stops” (close out orders) to be placed to protect any profits or limit losses.”


It’ll be clear that these products are not for the risk-averse, and that the client needs to be fully aware of the diligence issues. But many of the major providers do offer product knowledge and market experience to help guide advisers to make the implementation as successful as possible. And many also have education sections on their websites that explain the products in more detail.


The leverage issue also needs to be comprehensively explained, says Roff. And CFD providers and spread betting companies are compelled to conduct an appropriateness assessment for all new account applications. But, on the whole, “in an age of unlimited access to market data and company information these highly effective and efficient trading products are a perfect match for today’s sophisticated investor.”


One More Step Beyond

One rather different emerging trend is for an adviser or a DFM to set up a spread bet account that effectively encapsulates his client’s entire portfolio – a bit like a broker bond, except that the whole thing is contained within the tax-free wrapper.


The investor funds the account to 100% of the value of the underlying securities, and the adviser (normally) applies a fully hedged strategy that will ensure the safe return of the underlying assets – or rather, their value – under all circumstances.


That’s the theory, anyway. And the result ought to be a ring-fenced investment that isn’t leveraged and can’t lose more than 100%. Just like any normal securities share purchase, in fact. Particularly useful for wealth managers who may have a number of clients with similar aspirations.


But will it catch on? Watch this space.


Coming Soon

In the next few months we’ll be taking a closer look at the tax planning aspects of wealthier investors’ needs. Estate planning, trusts, pensions, and the legitimate boundaries of offshore and expatriate status. Please write to editor@ifamagazine.com and tell us if there’s anything what you’d like us to feature.

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