Investment, inheritance tax and business relief

Much of my time is spent advising clients on how to grow their investments. This involves protecting clients’ capital from various threats that can gobble it up, as fast as my Cocker Spaniel devours her supper. There is not a lot of point in planning for growth if you do not plan for protection of capital. Threats include stock market crashes, taxes, no longer suitable investment strategies and under-performing fund managers. That is why investment reviews are important.

In this blog I want to continue on the theme of alternative investments, specifically one that addresses one of the greatest threats to capital, inheritance tax (IHT). You can spend years building an investment portfolio only to find after your death it is decimated by a tax that wipes 40% off its value after various allowances. An antidote to IHT is legislation called Business Relief (BR). This was previously called Business Property Relief (BPR) and was introduced in 1976 to exempt business owners from IHT on business assets.  It also applies to shareholders in certain qualifying smaller companies. Providing the assets are relevant business property* investors are exempt from IHT after two years providing they are held at the date of death. The government is naturally keen to encourage investment in small UK companies, which is why tax incentives are provided.

The use of BR has become a mainstay of good IHT planning. It has two distinct advantages over other tax mitigation strategies notably outright gifts or use of trusts. These require a seven year waiting period for IHT exemption and the donor must relinquish all control of the asset gifted. There is no recall. In contrast BR applies after just two years and investors retain full rights over their investment. So if their circumstances changes and they need access to their money they can sell their shares and spend the money as they see fit, although of course they will lose the IHT exemption. BR address perhaps the most important reason why people don’t undertake IHT planning, the fear of losing access to capital. It also avoids the complexity of trusts.

Over the years a good competitive market has developed in tax efficient investments using BR. There are a host of providers including Octopus, Blackfinch, Time and Foresight and two types of BR investment schemes:

Investment Backed

These are managed portfolios of qualifying AIM shares. The AIM is the alternative investment market, part of the London Stock Exchange. It is a stock market for small companies. They are not all start-ups or fledgling companies and include established business such as clothing company ASOS, Fevertree Drinks and Youngs & Co’s Brewery. Domino Pizzas was AIM listed before moving to the main market as was Tottenham Hotspur football club before it went private. Not all AIM stocks qualify for BR, notably property and finance companies.

A number of my clients have managed portfolios of AIM companies which have delivered outstanding if volatile returns in the medium term. Since 2013 AIM shares can be held within an ISA which means dividends are not taxed.

Asset Backed

These are investments in one or more unquoted trading companies set up by the provider. The company invests in assets such as renewable energy, notably solar and wind, battery storage, property lending, anaerobic digestion, infrastructure and smart meter leasing. They benefit from physical assets, government subsidies and long term contracts with sustainable cash flows.

Asset backed BR schemes typically have an objective of steady capital growth and preservation and usually have a target return, for example 3.5% p.a. net of all ongoing management charges and costs. Many providers do not take their management fee unless investors receive the target return. They are especially suitable for cautious risk clients, ethical investors and people looking to deploy excess cash for a potentially higher return than bank interest but without taking undue risk.

A principle downside of BR investments are charges tend to be relatively high. Initial charges which have all but disappeared from mainstream investments such as unit trusts and OEICs (open ended investment companies) are levied by BR providers. These are typically 2% or 2.5% although IFAs may be able to negotiate discounts. Ongoing costs are also higher than unit trusts and OEICs. The other main disadvantage of BR investments are they are not covered by the Financial Services Compensation Scheme (FSCS) in the event of failure. This is no different to investors in any other direct shareholding.


The use of BR is an excellent way to mitigate against IHT, quickly, simply and without a loss of control of capital. An investment of £50,000 will result in an inheritance tax saving of £20,000 after just two years if retained until death. On death there will be no capital gains tax either. The underlying investments themselves will typically complement mainstream portfolios and add diversity. A number of providers offer accelerated tax relief with an option to add life assurance to cover the tax on death within two years. As a group life arrangement there will be no medical underwriting and acceptance is guaranteed unless you have been diagnosed with a terminal illness. That is the only question investors are likely to be asked. An additional charge is levied if the life cover option is selected.

There is a natural reluctance for people not undertake IHT planning. The reasons are varied but include loss of control, complexity and inertia. However someone once said inheritance tax is a voluntary tax paid by people who love their children more than the taxman, and inaction may be costly. In reality some of the barriers are easily overcome.

Finally BR is also available to Enterprise Investment Scheme (EIS) investors. These are the super heroes of tax efficient investments with a variety of other tax benefits including 30% income tax relief. More on EIS another time.

*Relevant business property. This includes a business or interest in a business, qualifying AIM shares, unquoted securities or land, buildings, plant or machinery for the purposes of a business. Relief for the latter is 50%. For a technical description see:

The content of this blog is based on my own understanding of Business Relief and is intended as general investment information only.  Nothing in this article should be construed as personal investment advice for example to invest in AIM shares or other BR schemes. You should seek individual advice based on your own financial circumstances before making investment decisions.

The State of the Nation – the US Economy

A number of commentaries I have read and listened to recently have been on the same theme, the US economy. Officially US growth is now in its longest expansion in history and with a dramatic shift in monetary and interest rate policy by the Federal Reserve, the US central bank, both equities and bonds have rallied in the US and elsewhere in 2019 after a sharp sell-off in the last four months of 2018. Recently the Dow Jones Industrial Average, the S&P 500 Index (the most representative stock market index of the US economy) and the technology laden Nasdaq all posted new highs.

Not all is rosy however with risks and threats from a slowdown as US tax cuts fall out of the equation, trade wars, political risks and a rising oil price. However when you look beyond the headlines the position is more nuanced and complex. Here are some random facts and observations from industry professionals that I found particularly interesting:

*China is expected to overtake the US as the world’s largest economy in 2020 according to John Husselbee, head of multi-asset at Liontrust. He sees ongoing geopolitical and economic tensions to be ongoing between the two superpowers even beyond the issue of tariffs, for example on the adoption of US or Chinese technology. I also suspect that the US economy will retain its global dominance even if the numbers place it in second place. So it might be the case that if China sneezes the world will catch a cold but if the US sneezes the world will get flu. One reason is that oil, gold, commodities and many emerging market bonds are all priced in dollars.

*The US economy has slightly decelerated in the first half of 2019 although according to Charles Kantor, portfolio manager of the Neuberger Berman US Long Short Equity fund (from an article in Investment Week along with the quotes from Pichoud and Lau below) the US macroeconomic backdrop is positive and supportive of growth. Karen Ward, a Chief Strategist at JP Morgan observed the US consumer economy is strong with low unemployment, wage growth and good personal balance sheets. However in my view rising inflation and a return to a policy of interest rate rises could be change this assessment.

*Adrien Pichoud, chief economists and head of multi-asset at SYZ Asset Management highlighted concerns about the US industrial sector where export order growth, CAPEX (capital expenditure) and job creation have effectively ceased. The question is whether this will be contained in the industrial sector or impact the wider economy.

*Larry Lau of the Trium Diversified Macro fund observes that fiscal measures to encourage corporate America to repatriate business back to the US has led to a mountain of debt whilst concerns about global trade incurs costs for business.

*The Bank of America Merrill Lynch’s monthly sentiment survey of fund managers showed investors are at their most bearish since the global financial crisis. Global managers have cut exposure to equities to a 21% underweight, the lowest since March 2009. I have to admit that surprised me.

So what are to make of it all and what are the prospects going forward. Those who called the end of the US bull market clearly have got it wrong. Three or four years ago I remember fund managers saying that the US was very highly valued and they were reallocating capital to the UK and Europe which were more attractively valued. The US market has continued its rally driven by earnings growth. It has been a gift that keeps on giving. I conclude there are potential rewards from equities and clearly risks as well. Whenever is this not the case? Karen Ward suggests to position portfolios defensively there should be a shift from smaller companies to large companies and from growth to value.* You will recall during recessions smaller companies fare poorly – evidence of this surfaced in late 2018 where prices were particularly badly hit. She also suggests a focus on quality. This will include companies with low levels of debt, strong barriers to entry and sustainable cash flows.

I conclude there are good reasons  to be invested in equities especially for the long term where you can ride out the short term volatility but also reasons or be cautious. I like Terry Smith of Fundsmith Equity fame. He takes the view even if you can accurately predict the global economy what can you do about it? He concentrates on what he can control – picking high quality companies and holding them for the long term. It has been a very successful investment strategy. I love his comments on his fund fact sheet:

No Fees for Performance

No Up Front Fees

No Nonsense (my favourite!)

No Debt or Derivatives

No Shorting

No Market Timing

No Index Hugging

No Trading

No Hedging.

*Growth and value investing are frequent terms you will hear banded about. The article from the US Fidelity website offers a good explanation: .

The content of this blog is based on my own understanding of US economy  and is intended as general investment information  only.  Nothing in this article should be construed as personal investment advice for example to buy equities or US funds. You should seek individual advice based on your own financial circumstances before making investment decisions.

Investment Trusts – Part 2

Before reading this article you may need to read part 1 written just over a month ago in order to refresh your memory on the technical backdrop. However to remind you of the key point – investment trusts have a closed end structure in contrast to OEICs and unit trusts which are open ended funds. Investment trusts have a limited number of shares in issue, whilst OEICs and unit trusts create and redeem shares or units respectively depending on investor demand. What this means is that the value of an investment trust’s assets (its Net Asset Value or NAV) may differ from its market capitalisation and the shares trade at a discount or premium to the NAV per share. If you get this, understanding investment trusts is a whole lot easier.

In this article I want to explain the benefits and uses of investment trusts for investors.

1. Investment trusts may mean investors can buy assets cheaper than their inherent value

Consider an investment trust trading at a discount to its NAV. Let’s us say the NAV per share is £1. What this means is if you add up the value of the investment trust’s assets i.e. the stocks and shares held, deduct liabilities, and divide by the fixed number of shares in issue each share has an underlying value of £1. However if the trust trades at a discount of 10% to its NAV the share price of the trust on the stock market will be £0.90. In other words an investor buying the trust will acquire £1 of assets for just £0.90. In this situation investors hope the discount will narrow and the share price will move closer to the NAV. If so investors benefit. In some cases this may be without any underlying investment gains on the trust’s portfolio of assets i.e. change to the NAV. For example if the share price rises to £0.96, investors who bought at £0.90 will see their investment rise by 6.67%.

The question is what might cause the share price to rise and the discount to narrow? It is all down to investor demand. To answer the question you have to ask why did the discount arise in the first place. The share price may less than NAV per share, the true worth of the shares for several reasons. One is investors lack confidence in the fund manager and their investment process or the outlook for the trust’s portfolio may be negative. If however an underperforming fund manager turns the investment around or is replaced by a new fund manager the market may take a more positive view of the trust, pushing up the share price. Of course the risk is that the discount widens and the share price falls.

Investors may also buy in at a premium to the NAV and pay more than their intrinsic worth of the shares. The most highly rated investment trusts with top fund managers trade at a premium. Investors buy in expecting further gains to both the NAV and the share price. However if you buy at a premium there is a risk the share price falls, moving closer to its NAV.

In contrast to investment trusts open ended funds are normally priced at NAV and investors cannot buy assets cheaper than their inherent value.

2. Investment trusts can borrow to invest unlike OEICs and unit trusts and may enhance gains

This is called gearing and it magnifies gains and losses. It makes investment trusts more risky than open ended funds although many trusts do not using gearing. Consider a trust which has £50 million of assets which borrows £10 million. If the trust gains 20% the value of the trust rises to £72 million. If the £10 million loan is repaid the net assets are now £62 million. The rise in value of the assets from £50 million to £62 million represents a rise of 24%, more than the 20% the market gains, although borrowing costs have to be taken into account. The reverse effect happens in a falling market, gearing amplifies losses.

3. Investment trusts can retain income for later distribution

OEICs and unit trusts are required to distribute all income they receive, both dividends and interest. However investment trusts can retain up to 15% of their income to distribute to shareholders at a later date. This enables trusts to smooth their income payments to investors as well as increase the dividends an investment trust pays out to its investors year on year. There are a significant number of investment trusts that have done this for 20 years or more and these are called “dividend heroes.” Data from the Association of Investment Companies (AIC)* and Morningstar show three trusts that have increased their dividend per share for 52 consecutive years – the City of London Investment Trust (UK Equity Income), Bankers Investment Trust and Alliance Trust (both in the AIC Global sector). The first ever trust, the F&C Investment Trust launched in 1868 has done so for 48 years.

Whilst the first two benefits might appeal more to growth investors taking more risk, investment trusts are clearly attractive to income seekers wanting steady and rising dividends, for example in retirement. In contrast the yields on open ended funds are more likely to fluctuate, be less dependable and less likely to keep pace with inflation.

4. Investment trusts can invest in less liquid assets than OEICs and unit trusts

Investment trusts are much more suitable for investing in less liquid assets such as physical commercial property, unquoted shares or infrastructure than OEICs and unit trusts. This is due to their closed end structure which means an investment trust manager is never required to sell the assets of the trust to pay exiting investors unlike their OEIC and unit trust siblings. If an investor wants to dispose of an investment trust they sell their shares independently on the stock market to a third party. There is no involvement of the investment trust manager and there is no call on the trust’s assets. It is no different in principle to owning shares of any other company. Let’s say lots of investors want to sell their shares in GlaxoSmithKline or HSBC they don’t sell them back to Glaxo or HSBC, they sell them on the London Stock Exchange to someone else. Glaxo don’t have to sell a research centre or HSBC close a few bank branches to pay out investors.

Just to make sure you are paying attention, here is a question. If lots of people sell their shares in an investment trust what happens to discount if there is one, or to a premium? I knew you were on the ball! You are correct, the share price falls and the discount widens. If there is a premium it will narrow and move closer to the trust’s NAV per share.

In contrast if lots of investors want out of an open ended fund they sell their units back to the fund and if there is insufficient cash available the fund manager will have to sell assets to raise cash. They may be forced sellers at depressed prices which reduces investment returns. If the underlying assets are illiquid there may be no market for them and the fund manager may be unable to deal. This may necessitate gating of a fund, i.e. stopping investors from redeeming their investment, like the Woodford Equity Income fund as explained in my last blog. As noted unit trusts holding commercial property on some occasions have had to close to dealing.

The fact that investment trust managers know there will never be a call on the trust’s assets to meet investor demand means that they can safely invest for the long term and that’s a big plus.

5. Investment trusts tend to outperform OEICs and unit trusts over the long term

The reasons for the superior returns are partly due to lower management charges levied by investment trust managers. However with the abolition of commission paid to advisers and payments to platforms by OEICs and unit trusts at the end of 2012, annual management charge differentials have fallen in recent years. Investment trusts are also more likely to have performance fees which adds to their costs but my assessment is the ongoing charges figures (OCFs – the annual management charges plus additional fund expenses) of investment trusts are generally lower than OEICs and unit trusts.

Other factors for the superior returns include avoiding cash drag (retained income can be invested whilst open ended funds may retain a cash buffer for redemptions) and the ability to invest for the long term. Gearing is another factor. Finally investment trusts tend to be smaller in size than the big beasts of the open ended world and therefore are more nimble with their investments. Of course there are plenty of exceptions here with poor performing investment trusts and OEICs and unit trusts with cracking returns. As ever good fund selection is crucial.

One interesting fact the AIC highlighted in a recent seminar I attended was the investment trust outperformance of sister funds. Many of the big fund management groups run both investment trusts and OEICs or unit trusts, for example Baillie Gifford, Janus Henderson, JP Morgan, Invesco, Fidelity and Schroders. In some cases there are equivalent investment trust and open ended sister funds, managed by the same person or team. They have similar investment strategies, asset allocations and stock selection. Typically over the medium to long term investment trusts have outperformed their sister OEICs or unit trusts.

Summary & Conclusion

Demand for investment trusts has risen in recent years but they have disadvantages as well as benefits. There are no outright ethically managed investment trusts as there are for open ended funds although there are a couple of environmental trusts and many investment trusts adopt ESG principles. ESG is Environmental, Social and Governance and has become a bit of buzz word amongst investment companies but in my view ESG is a very light green form of socially responsible investment (SRI), without strict adherence to a set list of excluded investments such as arms producers, tobacco stocks or companies involved in animal testing. There are no passive index tracking investment trusts, no equivalent to gilt and mainstream corporate bond funds and limited cautious risk multi-asset trusts. The point is investment trusts have limitations in what they can offer certain investors.

Whilst there is plenty of choice of trusts in major AIC sectors such as Global or UK Equity Income in some sectors it is very limited. For example there are just three environmental trusts, two equity and bond income trusts and one property securities trust. In part this in because there are only 338 investment trusts (excluding Venture Capital Trusts, VCTs) compared to around 3,000 OEICs and unit trusts.

So in conclusion, despite their complexity and some additional risks investment trusts can play a valuable role for suitable investors with their unique benefits and advantages, not enjoyed by OEICs and unit trust. They will however complement open ended funds not replace them.

*The AIC is the UK’s only trade body for investment trusts with around 90% of all trusts being members. Please note the terms investment company and investment trust are used interchangeably. The former is a more accurate description of what these investment vehicles are although the latter is still in common use.

The content of this blog is based on my own understanding of investment trusts and is intended as general investment information  only.  Nothing in this article should be construed as personal investment advice for example to buy  investment trust shares. You should seek individual advice based on your own financial circumstances before making investment decisions.

No bank branches were closed as a result of this article.

Woodford Equity Income Fund

It will not have escaped your notice that one of the UK’s best fund managers in the last 20-25 years, Neil Woodford has gone from hero to zero in the last few years. In an unprecedented move trading in his flagship fund, the Woodford Equity Income has been suspended. In investment speak it has been “gated,” meaning investors cannot sell their holdings. It has been all over the news. As many of my clients hold the fund I want to explain what I think is going here and provide some commentary.

Neil Woodford built up his formidable reputation at Invesco Perpetual running the flagship Income and High Income funds. Many of my clients benefitted from outstanding returns over many years. He famously avoided investment in technology companies during the tech bubble and eschewed the banks during and after the financial crisis. His success was based on being a contrarian, a value investor and an excellent stock picker. In 2014 he set up his own investment firm and launched the Woodford Equity Income fund. Investors piled in, in many cases on the advice of their IFAs. Guilty as charged. However things started going wrong a few years ago and since then a variety of companies that Woodford invested in have run into trouble including Provident Financial, Kier and Purple Bricks. He also has had problems with substantial investment in small unquoted technology companies. These carry additional risks compared to large listed companies. For a start unquoted stocks are illiquid, because they are not traded on a stock exchange and fledgling companies run the risk of outright failure. Finally Woodford’s value investment style has been out of favour for a long time although it was his bad stock picks that have primarily been the cause of his demise. Performance has been rotten in the last three years. Data from FE Trustnet (15/6/19) show the fund fell a whopping 21.6% in the 12 months. In contrast the average Investment Association (IA) UK All Companies sector fund fell by 4.0%. Over three years the Woodford Equity Income lost 17.4% compared to a 31.5% rise in the sector average. That is a heck of a difference.

Alarmed at the poor performance, investors started to pull money from the fund. Its assets fell sharply from around £10.2 billion at its peak to £3.7 billion but it was the recent acceleration in the rush for the exit that led to the decision to close it. The problem funds such as unit trusts and open ended investment companies (OEICs) have is unless they hold a substantial amount of cash the manager has to sell stock to meet investor demand. If the market or individual stocks are already falling, forced selling exacerbates losses for investors.

The gating of funds is not new. It has occurred with unit trusts investing in commercial property, notably during the financial crisis and for a brief period after the EU referendum in 2016. Commercial property is an especially illiquid asset and fund managers suspended trading to avoid being forced sellers at terrible prices or because there was simply no market for the properties. I can’t however recall a fund that invests in shares being gated. This is because aside from unquoted companies there is a ready and liquid market for trading stocks on recognised exchanges.

Given the problems with the Woodford Equity Income fund are not new you may well ask why I did not generally advise my clients to sell out, a year or two ago. I took the view like good footballers going through a bad period that “form is temporary but class is permanent.” Having seen my clients enjoy years of outperformance I expected Woodford to come good in the end especially if value investing came back into favour. Clearly like many others I did not appreciate the scale of Woodford’s problems. That said in recent years I recommended clients sell their holdings in the Invesco Income and High Income funds which shared a lot of similarities with the Woodford Equity Income, in order to reduce exposure to the same floundering investment style.

There are several scenarios that might play out in the next few months. Woodford will seek to reposition the portfolio during the suspension, for example to dispose of unquoted stocks and the best case will be that the fund will reopen to dealing in the near future. If Woodford rediscovers his touch we may see positive investment returns in the medium to long term. The worst case scenario is the fund is in terminal decline and will be wound up. Investors will be paid out, in most cases realising significant losses. Another option is the fund could convert to an investment trust, a closed end structure which protects the assets of the fund if investors want to sell their shares. This will be explained in part two of my coverage of investment trusts. Until we know the direction that events will take there is not much more to say. There is nothing we can do at this time.

So what lessons are there from this episode? Star managers can and do lose their Midas touch. That said I cannot recall a fund manager that has had such a spectacular fall from grace as Neil Woodford has. Secondly it is clear IFAs, like myself do occasionally recommend funds that turn out to be duds or even basket cases – disappointing for clients and embarrassing for advisers. I too am an investor in the fund.

At a broader level some will suggest this is a nail in the coffin of active fund management and that investors would be better off solely investing in low cost index trackers or Exchange Traded Funds (ETFs). I beg to differ but that is whole new issue. I do by the way recommend passive funds on occasions. Finally there may be calls for better regulation of fund managers whilst claims management companies may see a new business opportunity in seeking redress, now the PPI debacle is coming to an end in August.

This is an example of fund manager risk, one which can be rarely predicted and a reason why it is essential to diversify a portfolio.

The content of this blog is based on my own understanding of the Woodford Equity Income fund and is intended as general investment commentary only. Nothing in this article should be construed as personal investment advice. You should seek individual advice based on your own financial circumstances before making investment decisions.

Investment Trusts – Part 1

Aside from the US/China trade war flaring up again, this time with actual tariffs being put into place rather than just sabre rattling I don’t have a lot to say about the global economy or stock markets. So I thought I would begin a series of articles about alternative investment products. Some you will be familiar with, others you may know little or nothing about. Today’s topic is investment trusts. In the future I’ll look at National Savings & Investments, structured products, investment bonds and tax efficient investments such as venture capital trusts.

As an independent financial adviser (IFA) I am required under the rules to consider the full range of what the regulator, the FCA, call “retail investment products,” when deciding what might suitable for my clients. These are defined in the regulations although not entirely clearly. All the alternative products I will cover in these blogs fall into that category. Marketing of retail investment products and advice on them is fully regulated although perversely not all retail investment products themselves are covered under the Financial Services Compensation Scheme (FSCS) in the event of insolvency.

Due to the technical differences between investment trusts and other types of fund I will cover them in two articles. The first is the technical bit requiring a bit of hard work for the reader. The second will cover the more practical investment applications. Don’t worry if you don’t get everything in this article, the applications are more important and interesting.

What is an Investment Trust?

Investment trusts are collective investment schemes just like unit trusts and opened ended investment companies (OEICS), types of funds that you will be very familiar with. In essence an investment trust is a fund which holds a basket of shares or other securities, typically 50-100, similar to unit trusts and OEICs. This spreads and reduces investment risk. Investors money is similarly pooled and the investments are professionally managed.

Historically investment trusts have remained off the radar for several reasons despite being around for much longer than unit trusts,* having lower management charges and generally better performance. Firstly they never paid commission to advisers, secondly they have additional complexities and risks compared to unit trusts and OEICs and thirdly they cannot be advertised for sale. The reason for the latter is that investment trusts have a very different legal structure than their better known collective investment cousins such as unit trusts. An investment trust is not a trust. It is a company, a PLC. Investment trusts issue shares which are listed and traded on the London Stock Exchange (LSE). At least one, the Scottish Mortgage Investment Trust is a FTSE 100 company, others are FTSE 250 listed.

Being an investor in an investment trust is no different in principle to owning shares in any other company whether that is GlaxoSmithKline, BP or Tesco. The difference is that an investment trust’s business is to buy, hold and trade stocks and shares of other companies rather than manufacture and sell drugs, drill oil or sell corn flakes. You won’t see newspaper or other adverts from Glaxo, BP or Tesco to buy their shares because a marketing campaign would distort the market and drive up the share price. Remember share prices are determined by supply and demand. Similarly you won’t see adverts recommending you buy investment trusts per se although their monthly savings schemes can be promoted.

Closed End Structure

The company structure of investment trusts has several key consequences. Most importantly they are said to be “closed end” because there are a limited number of shares in issue. When investors buy or sell their shares in an investment trust it does not affect the underlying assets or holdings, just the share price of the trust. This means an investment trust’s share price can trade at a premium or discount to what is called its Net Asset Value (NAV) per share, see below.

Consider an investment trust with 10,000,000 shares in issue. If the share price on the LSE is £5 per share at a given point of time then the market capitalisation or value of the investment trust is calculated as for other listed companies, i.e. the number of shares in issue x the share price, i.e. £50,000,000. It is important to understand this is the value of the investment trust as a listed company, not necessarily the value of the underlying assets and investments of the trust. In fact in most occasions the two figures will differ.

If there is large investor demand for the investment trust its share price will rise – say to £6 and conversely if the markets take a dislike to it and investors sell, the share price will fall – say to £4. The number of shares in issue however does not change with the variations in the share price but the market capitalisation of the trust will fluctuate – in this case from £40,000,000 to £60,000,000. Changes in the market capitalisation of an investment trust do not necessary reflect changes in the value of the trust’s assets.

In contrast OEICs and unit trusts are “open ended.” Take unit trusts as an example. Consider a unit trust whose assets i.e. the shares and cash it holds are valued at £50,000,000 and there are 10,000,000 units in issue. You will see parallels with the figures for the investment trust above. So what is the unit price? You’ve guessed it correctly, £5 per unit! However investor demand affects a unit trust in a very different way to an investment trust. If money flows into the fund the manager creates more units and if money leaves the fund the manager redeems units. This is the meaning of the term open ended. For example Mr A wishes to invest £1,000,000 in the unit trust. (Probably not a great idea to invest so much, but it is the maths that matter). The price of units we’ve seen is £5 so the manager simply creates 200,000 more units for Mr A. The unit trust now has 10,200,00 units in issue and the value of the trust is now £51,000,000. The price per unit is still £5. Investor demand has not increased the unit price in contrast to the effect on the share price for an investment trust or any other listed company. The same is true if investors are selling.

So in summary an investment trust is closed ended as there are a limited number of shares in issue. Investor demand moves the share price. A unit trust in contrast is open ended, units are created or redeemed by the manager and investor demand does not affect the unit price, except in special circumstances outside the scope of this article. Get this and you are 75% on the way to understanding investment trusts.

Premiums & Discounts

The share price of an investment trust may trade at a discount (or premium) to its Net Asset Value (NAV) per share. The two move semi-independently. The NAV per share is the value of an investment trust’s assets divided by the number of shares in issue. To calculate the value of the assets of a trust each of the constituent stocks and shares held is valued, cash is added and borrowings are deducted. The value of each stock is the number of shares held by the trust x its share price.

The NAV per share is the inherent value of each share but typically this is different to the share price itself. For example we noted above that the investment trust above has 10,000,000 shares in issue, a share price of £5 per share at a point in time and a market capitalisation of £50,000,000. Let us say the value of the underlying assets also happens to be £50,000,000. If however the value of the underlying stocks and shares and other assets held by the investment trust for example cash grows to £55,000,000 the NAV of the trust is now £5.50 per share. However the share price may only rise to £5.25. An investor buying into the trust will now acquire assets worth £5.50 for just £5.25, the price they paid for the shares. The trust is said to be trading at a discount to its NAV.

In contrast if the assets of the trust are worth £45,000,000 the NAV per share is £4.50 and the investment trust has a share price of £5, it is said to trade at a premium to its NAV. This feature is the same as any other listed company which has a NAV per share and a share price which may differ. For example consider a listed company which is a major food retailer. Its assets includes the value of its properties and stores, stock, cash and debtors. Let us say the share price is £1. The following day a take-over bid is announced and the share price rockets to £1.20. The share price has increased 20% but the value of underlying assets will have barely changed unless they secure a great new deal on their corn flakes. The company is now trading at a premium.


In conclusion a closed end fund such as an investment trust as with shares of other listed companies typically has a share price that differs from the underlying value of the company’s assets. This is because the market has priced the investment trust shares on the overall value it perceives the company is worth, which may be more or less than just the value of the assets. Aside from the issue of potential take-overs the market makes assessments of future cash flows, profits and dividends, and business opportunities and risks.

Unit trusts and OEICs in contrast in general have unit and share prices respectively that equal their NAV and do not carry discounts or premiums. The difference has a profound impact on the benefits and disadvantages of investment trusts.

*The first UK investment trust, the Foreign and Colonial was launched in 1868. The first UK unit trust from M&G came to market in 1931.

The content of this blog is based on my own understanding of investment trusts. Nothing in this article should be construed as personal investment advice, for example to invest in investment trusts. These may not be suitable for you. You should seek individual advice based on your own financial circumstances before making investment decisions. Other cereals are available!

The global economy according to JP Morgan and Donald Rumsfeld

One of the best macro-economic and stock market commentaries I listen to is the JP Morgan’s quarterly “Guide to the Markets,” presented by the excellent Karen Ward, a Chief Market Strategist at the investment firm. In a recent webinar she naturally highlighted the 180 degree turnaround in market sentiment since the end of the year. The key factors have been the volte face in the US Federal Reserve’s monetary and interest rate policy, which has gone from hawkish to dovish, China shifting its foot from the brake to the accelerator with economic stimulus and a more favourable outlook for US/China trade deals. Equities and bonds have both rallied in the last few months.

Ward then considered the impact of the policy changes arising from the world’s two biggest economies. Firstly US monetary policy matters, both domestically and globally. On the former a pause on interest rate rises and quantitative tightening* makes corporate re-financing more affordable and it boosts consumer confidence in the US with lower mortgage rates. On the global stage a weaker dollar is a tail wind for commodities and it is positive for emerging markets with dollar denominated debt. In terms of trade whilst US exports accounts for just 13% of its GDP the US is the world’s third biggest exporter (Source: Trading Economics). Moreover the US runs a trade deficit i.e. imports more than she exports which is one reason that if the US sneezes the world catches a cold.

Interestingly Ward thought China’s stimulus is more significant for the global economic growth. She argued that China is still an emerging market with relatively low rates of urbanisation and real GDP per capita** and its expansion still has a long way to run. China of course has more influence on global trade than the US. The US economy is very consumer oriented whereas China’s is more export and infrastructure led which are both key planks of global trade. Infrastructure although domestic in nature requires raw materials and hence imports and trade. As an example of the importance of China and global trade Ward explained the poor European economy in 2018 was in significant part due to the Chinese slowdown. We also know that intra-Asian trade is strongly influenced by China. Moreover the US economy is expected to slow later this year as the sugar rush from Trump’s fiscal stimulus (corporation tax cuts and spending) reduces.

Whilst sentiment has much improved since the end of the year we are approaching a record for the length of the current global economic expansion. Everyone seems to agree we are late in the cycle. According to Ward equities are no longer screamingly cheap and for ongoing upward momentum in prices to continue we will need to see good corporate earnings growth coming through. The problem with being late in the cycle is that low levels of unemployment creates wage growth pressures which impacts on companies’ margins. Arguably recent US and Chinese policies will extend the cycle but for how long? Interestingly Ward says a late cycle favours investment in larger companies, quality and value.*** I’ll need to give that some thought. As you know I am a supporter of smaller companies.

My conclusion is that although equities have rallied in 2019 and markets are calm there are reasons to be cautious. Whilst there are known knowns such as the current economic stimuli, there are the known unknowns for example when will the cycle end and there are unknowns unknowns. The latter are potentially the most dangerous – unexpected geo-political events or unseen systemic economic threats could through a spanner in the works.

*Quantitative tightening (QT) is the reversal of quantitative easing (QE) in which a central bank offloads from its balance sheet the bonds it has acquired from money printing. QT reduces liquidity and causes bond prices to fall and yields to rise. Ward says that QT will come to an end earlier than predicted in the autumn . With interest rate rises on hold or set to fall (Ward says there is a 60% chance of this before the end of 2019) the bond market reacted very favourably.

**Real GDP per capita is the average contribution to the economy per head of population taking into account inflation. GDP is gross domestic product, a measure of the size of an economy.

***Value is an investment style that favours undervalued companies based on fundamentals. Since the global financial crisis investors have favoured a growth investment style with more visible earnings and superior growth.

The content of this blog are my own thoughts and assessments based on my understanding of the JP Morgan presentation. Nothing in this article should be construed as personal investment advice, for example to invest in larger companies or value investments.. These may not be suitable for you. You should seek individual advice based on your own financial circumstances before making investment decisions.

Unloved UK Equities

There is a general consensus that the UK equity market is unloved. So unloved it didn’t receive a Valentine’s Day card this year. Some have even considered the UK to be uninvestable. Of course Brexit uncertainty is the main concern for investors but the US/China trade dispute and a slowing global economy are additional factors. But is it all doom and gloom? Russ Mould, investment director at AJ Bell thinks not. In a recent article he noted the FTSE 100 index is up about 6% in 2019 – albeit this is a recovery from the sell-off at the end of 2018. Moreover the UK market is relatively cheap, with many stocks trading at very low valuations and the FTSE 100 has an attractive 4.7% p.a. dividend yield. What however piqued Mould’s interest were analysts’ forecasts of record earnings in 2019, estimated to be £223 billion, an increase of 13% on 2018.

Another notable point here is that at the previous peak in 2011 almost 50% of the earnings came from the mining and oil sectors. This time around the earnings base is more widely spread with banks and consumer staples such as Unilever and Diageo expected to make big contributions. Mould however does highlight a number of threats to bank earnings and of course forecasts are just that. They will depend on a number of factors including the strength of the pound. You may have noticed that when Sterling falls the FTSE 100 index tends to rise. This is because 70% of FTSE 100 company earnings are derived from overseas. If Sterling falls against the US dollar or the Euro the value of those overseas earnings translates into more pounds. Of course the converse is true.

Mould concludes the gloom is somewhat overdone and that meeting or beating earnings expectations could convince sceptical investors back into the UK equity market. I agree although I think a resolution of the UK’s future with the EU will be required first. That said contrarian investors, seeing the positive fundamentals may opt to invest early for the very decent yield of 4.7% p.a. and long term capital growth potential. Whilst I favour actively managed funds there is a case for buying exposure through a low cost index tracker fund to complement actively managed UK equity funds held in a portfolio. A word of warning though. The FTSE 100 index has been a rotten investment in the last nineteen years. At the end of 1999 it peaked at 6,930. Today at the time of writing it is trading at 7,388. Ignoring dividends the capital value of the index has risen by a measly 6.6% in 19.25 years, but as you know past performance is not necessarily a guide to future returns. That works both ways.

The contents of this blog are my own thoughts and assessments based on Russ Mould’s article. Nothing in this article should be construed as personal investment advice, for example to invest in UK equities or a FTSE 100 index tracker. These may not be suitable for you. You should seek individual advice based on your own financial circumstances before making investment decisions.

Global Debt – A Concern?

Equity markets have been calm and treading water in the last month after a good start to 2019. A less aggressive Federal Reserve and pause in US money tightening and has clearly been well received by investors. That said Standard & Poors, a leading ratings agency warned about global debt. In a recent report S&P, Next Debt Crisis: Will Liquidity Hold? they stated that global debt has risen by 50% since the global financial crisis in 2008, led by major economy governments and non-financial corporates in China. They warned another credit downturn may be inevitable although they considered contagion risk to be low.

The article in Investment Week that I read about the report stated that in absolute terms the US is the most indebted of all governments with an increase of $10.6 trillion of borrowing in the last 10 years. Debt in China and the Eurozone has also risen significantly. Interestingly household debt has decreased in the US and the Eurozone but it has surged in China.

S&P also noted the quality of the debt issued has deteriorated with large issuance of bonds with BBB credit ratings. As you are probably aware ratings agencies like S&P, Moody’s and Fitch rate the creditworthiness of bonds issued by governments and corporates. Although rating nomenclatures vary depending on the agency the most common is:

Investment grade – AAA, AA, A, BBB. BBB bonds are investment grade but are the lowest ranked of this quality.

Non-investment grade – BB, B, CCC, CC, C & D or variations thereof. In the US non-investment grade are often called junk bonds, just the sort of term to give investors a whole heap of confidence! Here in the UK high yield is the preferred description reflecting the fact that non-investment grade bonds must pay a higher coupon or interest rate to compensate investors for the additional credit risk they are taking. It is funny how the differing terminology colours the perception of whether non-investment grade debt is good or bad. Interestingly high yield debt is sought by income investors and it is less interest rate sensitive than investment grade bonds.

The higher the credit rating the more likely the issuer is to meet its obligations i.e. to pay interest and return investors’ capital at maturity. Bonds issued by the many Western governments and the strongest corporations tend to have AAA or AA ratings. According to S&P 61% of companies have aggressive or highly leveraged financial risk profiles. They also highlighted the greater use of non-traditional fixed income products and covenant-lite bonds with decreased protection for investors. These and BBB bonds are less liquid and more volatile than higher quality credits.

In a low interest rate environment default risk has been muted, but with rising rates and a slowing global economy defaults could pick up. Defaults range from the relatively minor, a delayed interest payment on a bond to the very serious not repaying bondholders their capital at maturity. However interest rate rises are a tool central banks use to curb inflation and inflation erodes the value of debt. Firstly inflation results in higher pay and prices and increases taxes which enables governments to pay down debt. In addition debts falls relative to assets. For example if you have a mortgage of £70,000 on a property of £200,000 and house price inflation results in a 30% increase to £260,000 over five years the ratio of debt to assets falls even if you have not paid off any of the mortgage. For corporates rising inflation may erode earnings. They may be able to increase the prices of their goods and services but labour costs rise as well.

So what do I conclude? Too much debt has a history of causing major economic problems. It happened during the Wall Street crash when people borrowed to invest in the stock market, subsequently wiping out a whole swath of the US banking sector. It happened in 2007-2009 when the US housing market and complex financial instruments built on debt collapsed, again bringing down the banks. It happened with Eurozone with the Greek debt crises and it is bound to happen again. That said undoubtedly the banks are much stronger financially now than they were during the global financial crisis, a decade ago. There are real risks but I don’t see too many red signals at this stage. Investing in equities for the long term should still deliver good returns whilst portfolios should be diversified and have a defensive core.

The content of this blog are my own thoughts and assessments based on the S&P report. Nothing in this article should be construed as personal investment advice, for example to invest in high yield bonds or equities. You should seek individual advice based on your own financial circumstances before making investment decisions.

Mini-Bonds – Too good to be true?

Recently I had an enquiry from an old University friend who is not a client. He got back in touch with me a couple of years ago. He asked me about an ISA he had come across from a company called Capital Bridge. It was offering 9% p.a. interest for three years. My old friend was clearly attracted to this fixed rate bond given the paltry rates of interest on offer from mainstream accounts. However he realised that it was more risky than a traditional cash deposit account as the underlying investments were loans to property companies. That said a salesman who called him after he registered interest seemed confident he would get 9% p.a. over three years. So what did I think?

Looking at the Capital Bridge website the bond offers 9% p.a. interest fixed for three years and is paid quarterly. Investors buy a bond which is held within an ISA wrapper meaning the interest would be tax free. To be fair there are plenty of risk warnings on the website and the downloadable brochure but I couldn’t find a link to the Information Memorandum or Prospectus, a detailed legal document required for the issue of bonds. However Capital Bridge make it clear that capital is at risk and there is no Financial Services Compensation Scheme (FSCS) coverage in the event of default unlike a traditional deposit account. As you are no doubt aware you are covered up to £85,000 if a mainstream bank or building society becomes insolvent. The Capital Bridge bond in terms of investor protection is no different in principle to investing directly in the shares or bonds issued by a UK company. If the company goes bust you may lose all your money and will have no recourse to the FSCS.

To reassure potential investors the website and brochure emphasise the due diligence that is undertaken in making loans to property developers and the security that is taken, notably the charges taken on the relevant properties. Phrases like hand-picked UK property developers, significant security and strict criteria suggest care and safety. Personal guarantees are taken from directors, loans are no more than 80% of the value of the property and they are valued by a Royal Institute of Chartered Surveyors surveyor.

To be fair it is made clear the security taken over the properties may be insufficient to repay bondholders and that property is an illiquid asset and the bonds may be difficult to sell. Oddly though it is stated that the investment into a Capital Bridge ISA should be a long term investment but I would not consider three years in any sense to be long term. The point is investors in the bond not only expect 9% p.a. interest for three years but a full return of capital at the end of the term. Where will Capital Bridge derive the cash to fully repay bondholders? All the loans will need to have been repaid in full at the right time. This in turn may require the properties to be sold at good values. Both are big asks.

There are plenty of other concerns about the product. Firstly interest payments are not guaranteed as these depend on interest payments made by the property developers. Secondly Capital Bridge is the trading name of Capital Bridge Bond Co 1 Ltd. It is not authorised and regulated by the FCA. Capital Bridge then pass investors’ money to a related company called Capital Bridge Finance Solutions Ltd (CBFS) who in turn make the property loans and take security on the assets. CBFS are also not an FCA firm. However the underlying investment is held within an ISA provided by Northern Provident Investments who are FCA regulated. That in of itself does not give legitimacy to the underlying investment nor provide investor protection. The ISA manager merely confers a tax free status to a unregulated investment and administer the interest payments. They have no liability for default for the underlying investments. Herein lies one of the problems of regulation, that an unregulated investment can be held within an ISA which is a regulated wrapper. It is similar to the position IFAs find themselves in. If I recommend a client buys an investment trust or exchange traded fund (ETF) for their ISA there is a confusing mix of investor protections. The advice I give is regulated, the ISA plan manager is regulated but investment trusts and ETFs are not and investors have no recourse to the FSCS if the investment goes bust, unless an adviser gave bad advice and the IFA firm itself is in default.

Interestingly the enquiry from my old university mate came at a time when a company called London Capital & Finance (LCF) no long earlier went into administration. They offered a similar 8% p.a. fixed rate bond held within an ISA. There is a page on it on the FCA website:

Also you may have listened to Money Box on BBC Radio 4 last Saturday which covered this story. Around 14,000 customers had invested around £214 million into the bond. Investors may get little or nothing back once the administrators and other debtors get paid. While the asset backed nature of the Capital Bridge loans are different to those made by LCF both are mini-bonds and carry the same risks. The FCA write:

“A mini-bond is an unlisted debt security, typically issued by small businesses to raise funds.

Mini-bonds can be attractive to investors because of the interest rates on offer. However, prospective investors need to understand the associated risks. Mini-bonds are usually illiquid as they are not transferable, unlike listed retail bonds, which they are often compared to. They can also be high risk, as the failure rate of small businesses can be high. Additionally, as with the issue of other non-transferable corporate bonds, there is no Financial Services Compensation Scheme (FSCS) protection if the issuer fails.”

Another concern lies with the fact that the bonds are issued Capital Bridge Bond Co 1 Ltd. They will have very limited assets of their own as they have passed over investors’ cash to a separate legal entity CBFS. I could write more but in conclusion I would not invest in such a bond myself and would actively dissuade my clients from doing so. It looks too good to be true. There are simply too many concerns and risks for me, whilst better investments exist elsewhere. Structured deposits or structured capital at risk products are options for high potential returns along with adventurous equity funds. I plan to write about the former at a later stage.

The content of this blog are my own thoughts and assessments. Nothing in this article should be construed as personal investment advice, for example to invest in structured products or equities. You should seek individual advice based on your own financial circumstances before making investment decisions.

Positive Start to 2019

In my last blog post on 10/1/19 I highlighted a number of things that would be good for equity markets, the first was the Federal Reserve, the US central bank pausing on interest rate rises. On Wednesday the Fed announced borrowing costs would be unchanged. The tone of their statement was much more dovish than previously. They recognised that inflation was muted and remains close to its 2% target. The Fed also expressed it was willing to be flexible on its Quantitative Tightening (QT) programme. QT is the reduction in US government’s balance sheet, which is rolling off $50 billion of bonds each month, thereby reversing QE. In December the Chairman of the Fed, Jerome Powell had said the balance sheet reduction was on autopilot, which spooked investors. The pause was also in recognition of domestic and global economic “cross-currents,” including the US/China trade war, weaker growth in China and Brexit and the harm that an aggressive monetary policy could have on financial markets.

The markets liked what they heard, with a rally in equities around the world. The dollar fell against most of its peers and gold rose to an eight month high. In general commodities prices are inversely correlated with the dollar because they are priced in dollars.* A weaker dollar is also positive for emerging markets.

It is early days yet but January was a better month for investors after the sell-off between September and December.

*Commodities are priced in dollars. What this means is that they become cheaper in local currencies if the dollar weakens, even if the underlying price of the commodity e.g. gold or oil does not change. For example if the £:$ exchange rate is £1 = $1.30 and the dollar weakens to £1 = $1.40, a UK investor buying dollars to buy gold acquires more dollars for a fixed investment and hence acquires more gold.

The content of this blog is intended for general commentary only and is based on my understanding of current stock market conditions. Nothing in this article should be construed as personal investment advice, for example to invest in equities. You should seek individual advice based on your own financial circumstances before making investment decisions.