December 2021

As 2021 draws to a close, investors can look back on a year that still presented challenges, despite conditions being much more benign than those experienced a year earlier. Following the very sharp recession seen at the start of the pandemic, we have witnessed a broad based economic recovery, fuelled by continued economic support from central banks and governments, which has continued to provide markets with the confidence to move forward.

At the time of writing, the S&P500 index of US shares stands 27% higher than at the start of the year, whereas the FTSE100 stands 12% higher. These increases have built on the strong returns seen during the latter part of 2020. Whilst most investment markets are higher than at the start of the year, there have been areas to avoid. Chinese markets, weighed down by concerns over the debt-laden property sector and government policy, have fallen throughout the year, despite a modest recovery seen over recent weeks. The safest government bonds have also seen disappointing returns, as inflationary pressures bite.

Compared to the wild swings in sentiment seen during 2020, this year has seen more stable conditions for investment markets. Apart from some volatility around the time that the Omicron variant was discovered, investment markets have sailed through much calmer waters than was the case a year ago.

As we progressed through the year, investor attention began to shift away from the pandemic, and the increasing rate of inflation being seen in Western economies became the primary concern. In the UK, the Consumer Price Index hit 5.1% in the 12 months to November 2021, the highest level for a decade. We are not alone in facing higher inflation, with the prevailing rate in the US standing just short of 7% per annum. A number of factors have contributed to the increase in inflation – demand for goods such as building materials and microchips has outstripped supplies, and the cost of shipping goods has also risen sharply. We have all felt the impact of higher gas and electricity prices, and food prices also continue to rise. Spare capacity in the labour market may also lead to modest levels of wage inflation, as certain sectors, such as hospitality and logistics, struggle to hire employees.

The heightened rate of inflation is unlikely to be welcome news for many. Whilst higher rates of inflation are helpful in eroding levels of debt, for households struggling with increasing energy costs, and for those individuals holding cash savings, these are painful times. Central banks would ordinarily be looking to increase interest rates at this point in the economic cycle, to combat the higher rates of inflation. However, they need to tread carefully to avoid damaging the fragile economic recovery. Taking away the support and raising rates too quickly could reverse the economic gains achieved since the height of the pandemic, whereas leaving rates on hold for too long could stoke inflationary pressure further.

The Bank of England was the first to jump, raising rates from 0.10% to 0.25% this month, and we expect most Western central banks to continue raising rates during the course of 2022. The pace of these rate increases is likely to be a key factor in determining how markets perform during the course of the year, and clear forward guidance – such as we are seeing now from the Federal Reserve – will be needed to avoid markets being spooked by unexpected changes in policy.

So where do markets go in 2022, and what is in store for the coming year? Firstly, the emergence of Omicron reminds us that sadly the pandemic is not over. Investors have faced continued uncertainty in the face of the virus since March 2020, and it is becoming clear that Covid-19, and the actions taken by governments to combat the spread, is once again going to dominate market sentiment as we head through into the New Year. As we have seen over recent weeks, governments around the world appear to be keen to avoid the kind of restrictions that could deal a substantial blow to the economic recovery, but they need to balance this with the need to protect public health.

The actions of central banks will also likely have an influence on market confidence. The rapid rise in inflation may well remain a headache for policymakers throughout next year, and tough decisions on removing key support that has been in place since the start of the pandemic could have negative consequences. Inflation may well start to moderate as we move through the next 12 months, although we suspect prevailing inflation rates will stay a little higher for longer, placing further pressure on central banks and savers.

We will be watching corporate earnings closely as we move through into 2022. By and large, profits have held up well and in some sectors have exceeded expectations this year. We do, however, need to be mindful that the valuations of some sectors of the economy are now looking a little expensive.

Finally, in contrast to the calm conditions we have seen through this year, we may well see a little more volatility return as a result of Omicron and the key interest rate policy decisions that will need to be taken. For this reason, 2022 could well be a year when paying careful attention to asset allocation, and maintaining good levels of diversification, are crucial to navigate the prevailing conditions successfully. Rest assured we are here to provide guidance and reassurance whenever needed.

If you are interested in discussing the above with one of the experienced financial planners at FAS, please get in touch here.

May we take this opportunity to wish you a peaceful, happy Christmas with good health and prosperity in 2022!

This content is for information purposes only. It does not constitute tax planning or financial advice.

Over the years, governments have introduced, and then replaced, a variety of schemes to stimulate investment in new and small businesses. A key feature of all these schemes has been some type of tax incentive. The Treasury views these tax sweeteners as a necessary cost to attract ‘patient capital’ from private investors. The net result is that today the rules governing the three current schemes – venture capital trusts (VCT), enterprise investment schemes (EIS) and seed investment schemes (SEIS) – are highly complex. Before embarking on investment in any of this trio, it is crucial to understand the constraints that surround them, the inherent risks, as well as the potential rewards.

Relief on investment

All three schemes – VCT, EIS and SEIS – offer income tax relief on the initial investment into new shares, with VCT and EIS providing 30% relief, and SEIS offering 50% relief. These reliefs are subject to a number of conditions, primarily being the minimum holding periods. VCTs need to be held for at least five years and EIS and SEIS for at least three years, to avoid the relief given on investment being clawed back on disposal. In addition, it is important to note that income tax relief can only be obtained on income tax actually paid.

Over recent years, this income tax relief offered has become a key attraction for many high-income investors who find their scope for pension contributions has been constrained or eliminated completely by the reductions in the pension lifetime and annual allowances.

HM Treasury does not give tax relief without good reason. In the case of VCT, EIS and SEIS, that reason is the risk that the investor is expected to accept. This was underlined by a change to the legislation for all three schemes introduced by the Finance Act 2018. Broadly speaking, any underlying company in which investment is made must now satisfy a “risk to capital” requirement. For investments in companies that qualify for relief, the investment needs to demonstrate that the company has objectives to grow and develop over the long-term, and there needs to be a risk that there could be a loss of capital to the investor of an amount greater than the tax relief provided.

The aim of this test is to prevent low risk, growth-averse companies from being established solely for the purpose of accessing the tax reliefs available. It has had the desired effect, with VCT and EIS providers regularly reminding investors that the returns are likely to be more volatile than before the 2018 change.

Other tax incentives

In addition to the income tax relief on a qualifying investment, VCT dividends are tax-free and many VCTs focus on returning capital to shareholders through the payment of regular and special dividends. EIS and SEIS investments qualify for business relief after being held for 2 years’ ownership. This grants the shares in EIS and SEIS exemption from inheritance tax, as long as the shares are held until death. EIS also offers investors the ability to defer capital gains tax charges for gains made between 3 years before to 1 year after investment.

Risk to capital

It is important to acknowledge that investment in any of these schemes involves holding shares in very small and fledgling companies. These companies are seeking capital to help them grow, and whilst there are substantial success stories where exceptional returns have been achieved, the risk that these companies fail to deliver is also considerable. By way of example, companies that qualify for VCT funding need to hold assets of less than £15m at the time of investment and have fewer than 250 full-time employees (or 500 for so-called “knowledge-intensive” companies). SEIS qualifying companies are much smaller still, with the company needing to hold gross assets of less than £200,000 and have fewer than 25 full-time employees.

An additional risk is the fact that these investments can be hard to sell once the minimum holding period has elapsed. VCTs are listed on the London Stock Exchange (LSE), but trading in smaller issues can be thin, partly because of the tax relief clawback rules. That being said, VCTs normally offer a buyback route, where the shares are re-purchased by the company at regular intervals, at a discount to the underlying asset value. EIS and SEIS investments are not quoted on the LSE, and disposing of these unquoted investments relies on finding a buyer for the shares, which can take some time.

The importance of advice

It’s necessary to point out that VCT, EIS, and in particular SEIS investments involve a higher level of investment risk when compared to the likes of other equities, bonds and cash. The potential returns, of course, can be higher than those provided by more traditional asset classes, and the various tax incentives are attractive.

Selection of the appropriate investment is vitally important, as there can be vast differences in performance between individual VCT and EIS funds. Different investment approaches are also taken, with some focused on a specific area or field, and others being more generalist in nature. For this reason, you should always discuss this with one of our experienced financial planners first to ensure that any VCT or EIS investment sit appropriately within your investment risk profile, time horizon, and your other assets and investments.

If you are interested in discussing your VCT, EIS or SEIS investments with one of our experienced financial planners at FAS, please do get in touch here.

This content is for information purposes only. It does not constitute investment advice or financial advice.