I was interested to read a report from HSBC Life called The Three ‘I’s of Investable Capital.
It was fantastic to see a big name in the industry shine a light on the value of tax planning.
Focus was given to the power of tax relief in producing good outcomes for clients – a topic I covered in my last column for Money Marketing. The report noted that even low levels of return on an investment can be transformed into an attractive post-tax outcome because of the impact of tax relief.
If clients are going to invest in venture capital anyway, it makes sense to advise on the opportunity
As Consumer Duty has placed emphasis on good client outcomes, the value of advice and the justification of fees, tax-efficient investments stand out as an opportunity for advisers to explore.
But are clients and advisers making the most of them? Research we commissioned suggests this might not be the case.
Just 17% of advisers we surveyed think their clients are interested in investing in early-stage companies. And yet 45% of investors are keen to explore the asset class.
This gap is reflected in what advisers currently advise on when it comes to tax-efficient products, specifically those that invest in early-stage UK companies. While more than 90% advise on pensions and Isas, only 36% advise on venture capital trusts (VCTs) and only 27% advise on enterprise investment schemes (EIS).
There’s an adage in venture capital that the best startups choose their investors
It’s clear from the survey results that clients value being able to add early-stage companies to their portfolio. Obviously, just because a client is attracted to investing in UK startups, it doesn’t automatically mean they should – venture capital is high risk and some clients won’t be suitable. But what’s important is that a conversation takes place and that advisers don’t miss an opportunity to add value.
Such is the level of interest from clients, many seek out investment opportunities off their own back, typically making single-company investments in startups through crowdfunding platforms. If clients are going to invest in venture capital anyway, it makes sense to advise on the opportunity.
As managed products, VCTs and EIS are likely to offer greater levels of diversification. The calibre of investment pipeline can also be superior.
With rebalancing, a broader range of clients than you might expect could benefit from exposure to venture capital
There’s an adage in venture capital that the best startups choose their investors. And the reality is that some of the best companies and management teams seek out specialist investors as funding partners because of the ongoing support they can give.
So what’s preventing conversations taking place between advisers and clients?
I think a big part of the picture is a misunderstanding around how to approach the risk inherent in venture-capital investing. That misunderstanding can lead to a narrow view of who EIS and VCTs should be considered for.
There are two threads to this. The first is that a goals-based risk approach means a client doesn’t have to be a high-risk appetite overall to consider venture capital. It is acceptable for a client to hold different investments to achieve different objectives and for those investments to vary in risk.
By adding relatively small exposures, investors could improve potential annual returns by 0.5% to 1% without changing the overall risk
Building on this, advising on venture capital is about being holistic and considering the proportion of assets a client has at risk in venture capital, relative to other assets in their portfolio. With rebalancing, a broader range of clients than you might expect could benefit from exposure to venture capital.
This is something we have explored with Hardman & Co in a joint whitepaper. Dr Brian Moretta, head of tax enhanced services at Hardman & Co, researched the effect of adding venture capital to client portfolios.
He looked at risk through the lens of variance (the volatility of returns for each asset class) and used this to establish the optimum allocation, producing the best return for a given level of risk across a portfolio.
Many clients will be open to their adviser suggesting investments with the potential for attractive post-tax outcomes
Remember that other risks and considerations for suitability are at play, for example liquidity and investment time horizon. Any suitability decisions must be based on a full review of your client’s objectives, needs and attitude to risk.
Dr Moretta found that, while you can allocate to venture capital and build an accordingly higher risk portfolio for clients who wish to take on more risk, clients can also invest in venture capital while managing portfolio risk. This happens through rebalancing their portfolio, disproportionately increasing the weighting of lower risk assets as venture capital is introduced.
Dr Moretta’s research found that by adding relatively small exposures to venture capital, investors could improve potential annual returns by 0.5% to 1% without changing the overall portfolio risk. While this might not sound like much, the impact of compound returns could be significant.
The UK has seen a period of higher inflation – and wage inflation – against frozen tax thresholds. So many clients will be open to their adviser suggesting investments with the potential for attractive post-tax outcomes. EIS and VCTs are well worth your time to get to grips with.
Jess Franks is head of investment products at Octopus Investments
