As we enter the last quarter of the tax year, there will be plenty of people looking to use their annual £20,000 ISA allowance. Some of them will be considering transferring some or all of their ISA pot into a portfolio of AIM stocks as part of their planning around inheritance tax (IHT).
An ISA forms part of an individual’s estate upon their death and some AIM stocks qualify for business relief, which provides IHT relief if certain conditions are met. So what should advisers considering this route as part of a client’s estate planning be looking out for? How should you evaluate the service, how can you compare the different products on offer and what questions might you ask the investment manager?
* Bring in an expert: First off, I would use a portfolio service managed by an investment manager who specialises in investing in the AIM market, rather than trying to do it yourself. Investing in AIM-listed companies can be notoriously difficult, even for seasoned investment professionals.
For proof, we need look no further than what happened with Patisserie Valerie and Conviviality – both AIM-listed companies. It takes a huge amount of time and experience to invest wisely in these types of earlier-stage, growing businesses and it is not the ideal forum for direct investment by individuals.
There are additional factors that compound this situation, including the fact the companies selected must qualify for business relief – and continue to do so through the life of the investment. Again, this is something a specialist investment manager with the time, skills and resources focused on investing in AIM stocks is better suited to doing.
* Make the most of available resources: There are a number of sources of information and research such as MiCap and MJ Hudson Allenbridge that you can use as part of this process but there really is no substitute for the ultimate decision-making tool, which is to meet or speak to the manager directly.
Frustratingly, it is often difficult to compare managers on a like-for-like basis as, for instance, they often report things like performance slightly differently. As such, it is important not just to rely on the research for your buying decision and to actually meet the manager to gain a better understanding.
Having said that, there has been some progress in the service comparison arena, with Asset Risk Consultants launching an AIM IHT Portfolio Index. It currently only has 10 or so constituents, but is a good starting point to analyse the peer group.
* Consider all charges: Obviously charges are an important thing to consider. Most investment managers charge some form of initial (anywhere from 0% to 2.5%) and ongoing (typically 0.75% to 1.5%) fees. The one fee that is often missed by investors, however, is a dealing charge.
An initial fee of sorts by a different name, this is usually taken on the purchase of shares and sometimes on the sale of shares. It gets lost because often people are given an initial fee discount resulting in a 0% initial charge which causes them then to miss the fact the manager is taking a 1% dealing fee. This is not the charge taken by the broker, but is in fact taken by the investment manager.
This charge is then taken every time stocks are bought and sold throughout the duration of an individual’s investment. Given most portfolios will have around a 10% turnover per year, the 2% charge (1% on sale and purchase) will add up and is definitely worth considering when looking at managers, as not all managers will charge this. Equally, the impact can be reduced by choosing a manager who has a low portfolio turnover.
* Don’t forget investment matters: It is amazing how often, when purchasing tax-efficient investments, people focus on the tax reliefs rather than the investment case and fail to ask a manager the questions that are likely to define potential investment performance.
Looking at the size of the portfolio, the average market capitalisation, the value of those companies compared with the peer group, how much debt they have, how many are paying dividends, what sectors they invest in or avoid, where have they positioned the portfolio … the list goes on.
It is crucial to understand this and see how a manager articulates answers to such questions. You need to be confident in their ability to manage through all market conditions – especially given the current volatile investment climate we currently find ourselves in.
Less of an issue now, perhaps, given the recent market sell-off, but portfolio valuation is another important thing to look at when considering a manager. People often think managers investing a client’s capital for IHT in AIM are all investing in the same stocks – typically the largest, most liquid ones that are found in the top 30 or 50 on AIM (and also often the most expensive).
While there are certainly managers that do have exposure to these stocks, there are plenty of managers that look beyond that top 30 or 50 and the average market capitalisation. Comparing portfolio valuation to the market is one way to assess such managers.
* Assess access and platforms: Once you have done your due diligence, perhaps the final bit of the jigsaw is how you access or purchase your chosen provider. Traditionally, investors have had to invest directly with the manager – however, in the last two years or so, there have been a number of providers that have made their services available on platforms such as Transact and Standard Life. Although certainly useful for the right client there are some key differences worth noting.
Going via the platform offers the benefits of good ongoing reporting/valuations in the same architecture as a client’s other investments on the platform. It is also likely to be cheaper – certainly in the first instance – as the manager’s initial fees and dealing costs are no longer there. Yes there is a platform cost, but this can be offset by the potential dealing fee when investing with a manager directly.
The one major downside, however, is around the initial portfolio construction. Dealing through the platform can be more restrictive than when it is done by an investment manager and that is also worth bearing in mind.
Jack Rose is head of tax-efficient products at LightTower Partners