August 2022

Aug 25

Plan ahead to fund further education

By FAS | Investments

As the A-level results are announced, students up and down the country are busy securing their place at University. The future funding of further education is a growing concern, highlighted by press reports at the weekend that tuition fees will need to rise considerably above the current level of £9,250 per annum over coming years. Add on top all of the other costs of living in student accommodation, it is little wonder that further education funding is a common topic of conversation when advising parents and grandparents.

The Student Loan system is designed to provide support for tuition fees, and as a result, finding the money up front to pay for learning costs is often not an issue. This system does, however, saddle young people with significant debts, which are only repayable once earnings exceed a certain threshold. Maintenance costs are, however, means tested, and given the cost of accommodation, living expenses, food, study materials and socialising, this can run into several thousand pounds a term.

This is why we are often called to advise families on the best way to fund these expenses for their children. We will explore a number of ways this can be achieved.

Regular saving

Most of us are familiar with the notion of regular saving for retirement through a pension, which aims to provide an income in later life. We can look to take the same approach, but with a much shorter time horizon, by setting up a regular savings investment plan. Whilst using cash is an option, it is rarely sensible to use cash for an investment of this type as returns are generally low and inflation can eat away at the real value of the sum saved. By using investments into other assets – such as Equities (Company Shares), Fixed Interest Securities (Bonds and Gilts), Property or Infrastructure – returns in excess of those generated by cash can normally be achieved over the longer term.

The investment can be held in the name of a parent, which retains control over the investment fund, or potentially could be invested through a Junior Individual Savings Account (ISA) in the hands of the child. The latter option does provide immediate access to the funds when the child is 18, which could be a consideration if a parent has concerns that the child may use the funds for other purposes than intended.

An additional benefit of investing regularly is that the monthly contributions will purchase investment fund units at different values, and therefore a smoothed investment effect known as “pound cost averaging” can be achieved.

The earlier a regular savings plan is commenced, the greater the time horizon for investment. This can lower the risk of the investment plan as investments in assets other than cash should really only be considered when the investment can be left in place for five years or more.

Lump sums and gifting

Grandparents in particular are often keen to help future generations, by helping them fund their grandchildren’s study costs. This can potentially have a dual benefit, as making gifts at an earlier point can also ease concerns over Inheritance Tax liabilities that Estates may be burdened with in the future.

As with regular savings, a lump sum gift could be placed in a cash savings account; however, as described above, returns on cash over time are generally poor, and investing the lump sum into a suitable investment plan can often yield better returns.

When establishing an investment of this type, there are options to consider as to how the investment is structured. To also be effective for Inheritance Tax planning, the gift needs to be absolute, which means either passing funds to the parents of the child to hold for the benefit of the child, or establishing a Bare Trust.

Bare Trusts and tax efficiency

Assets in a Bare Trust are held in the name of a trustee. However, the beneficiary has the right to all of the capital and income of the trust once they reach the age of 18. This means the assets set aside by the settlor in Trust will always go directly to the intended beneficiary and there is no discretion as to who receives the benefit.

The advantage of using a Bare Trust set up by a Grandparent is that whilst the assets are held by the trustee, any income generated by the investments are taxed on the beneficiary, i.e. the child. As children are entitled to the Personal Allowance before Income Tax is paid, this effectively means that no Income Tax charge will arise. It is important to distinguish this tax advantage from the situation that occurs when a Bare Trust is set up by a Parent, rather than a Grandparent. In this instance, the Parent is deemed to be the “settlor” and if income of more than £100 per Tax Year is produced, the entire income is taxed on the Parent, and not the Child.

Success is down to careful planning

Whether a regular savings approach is adopted, or a lump sum invested, the success of any plan to save for University costs will rest on the performance of the investment strategy and funds selected. FAS can provide independent advice as to the type of strategy that should be adopted, and discuss aspects such as investment risk and volatility and also address any ethical considerations.

As with any investment plan, regular reviews should be carried out to ensure the investments are performing as expected and given that funds will be needed at a known point in time, it may well be appropriate to consider reducing investment risk as the child nears the point that the funds are needed. This can help avoid the potential for markets to suffer a downturn at the time that funds are to be withdrawn. At FAS, we provide ongoing advice and regular reviews to consider whether the underlying strategy should be altered during the life of the investment.

If you would like to plan ahead to fund further education costs, or are considering gifting funds for this purpose, then speak to one of our advisers here.

The value of investments and the income they produce can fall as well as rise. You may get back less than you invested. Past performance is not a reliable indicator of future performance. Investing in stocks and shares should be regarded as a long term investment and should fit in with your overall attitude to risk and your financial circumstance.

Aug 18

Piece of paper torn back to reveal text reading Inheritance Tax

Get relief from Inheritance Tax

By FAS | Tax Planning

The recent news that Inheritance Tax (IHT) receipts jumped by 14% in the 2021/22 financial year was of little surprise, given the IHT tax take has been steadily increasing for some years. The total amount of IHT raked in by the Treasury was £6.1bn in the last financial year, and the Office for Budget Responsibility predict the IHT bill will increase to over £8bn by 2026.

With property prices rising over recent years, coupled with long term increases in the value of other assets, more and more families are finding the estates of their loved ones are subject to IHT. The Nil Rate Band – the amount you can give away before IHT is charged – is frozen until at least 2026, and it is therefore unsurprising that the expected IHT receipts are set to rise.

For those where their estate is likely to exceed the IHT threshold, the good news is that sensible financial planning can help ease the potential tax liability. There are a number of methods to look to mitigate an IHT bill, and one tool available are assets that qualify for Business Property Relief (BPR).

Relief after two years

BPR was introduced in the 1976 Finance Act, and it was created to allow small businesses to be passed down through generations without facing a large IHT bill. The scope of the Act has widened so that it now allows investors of qualifying companies, as well as the business owners themselves, to obtain relief.

The tax relief is granted once an individual holds shares in a qualifying company for a minimum period of two years. The shares need to be held by the individual so that the qualifying assets remain held by them at date of death, and the shares must remain qualifying throughout the holding period.

The two year holding period is certainly more attractive than the requisite timescale needed for gifts made by an individual to escape IHT. Gifts in excess of annual exemptions are known as Potentially Exempt Transfers, and remain in an individual’s estate for a period of seven years.

A further advantage investments that qualify for BPR have over the gifting route is that funds are retained by the individual. If access to the capital is required, then the shares can be sold to raise the necessary funds. Of course, the value of the shares sold will return to the potential estate for the purposes of the IHT calculation.

BPR and AIM shares

To qualify for BPR, shares need to be purchased in unquoted companies, or selected shares listed on the Alternative Investment Market (AIM), which is a UK market primarily used by smaller companies. A wide range of investment managers have produced Discretionary Managed portfolios of shares that they believe will qualify for BPR, either through investments in unquoted companies, or through qualifying shares that are listed on the AIM market.

Where investment managers use unquoted companies, they will often adopt an investment approach whereby funds are allocated in businesses that engage in trades such as renewable energy, property or business lending. These types of strategy often look to generate modest returns over time. Shares in AIM are likely to be more volatile, due to the often unpredictable nature of smaller companies, where business fortunes can often change rapidly.

Whichever approach is adopted, it is important to acknowledge that buying shares in smaller or unquoted companies, is likely to carry additional risks than investing in larger and more well-established companies. In particular, the shares of unquoted companies may be harder to sell.

Political interference

Whilst IHT tax legislation has been stagnant for some time, a risk of any longer term planning is that the tax rules are changed after plans have been put in place. This could potentially have the effect of undoing prudent measures to restrict or eliminate the tax bill.

IHT is an easy tax to collect, as the personal representatives of an estate that is liable to IHT cannot obtain the grant of probate to deal with the estate until the IHT has been paid. Furthermore, beneficiaries of estates that are liable to IHT may be perceived by some quarters as receiving a large inheritance, and potentially makes IHT a soft target when it comes to raising revenue.

Both Tory leadership candidates have mooted that they would review the current IHT regime if they were elected as Prime Minister, and opposition parties have also laid out plans in previous manifestos to reform the way that estates are taxed. Reform of the IHT rules is likely in the longer term, and it is therefore important that plans can adapt to potential changes.

Get the right advice

Given that IHT planning is carried out with longer term objectives in mind, it is important to obtain appropriate advice from experienced financial planners. Investments that qualify for BPR are complex and given the wide choice of options available, it is important that providers and products are selected carefully. At FAS, we are adept at providing clients with comprehensive IHT planning advice as part of our holistic advice service.

If you would like to discuss how to reduce the impact of IHT on your estate with one of our experienced advisers, please get in touch here.

Aug 11

Photo of the Bank of England building - Fifteen months of recession

Looking on the bright side

By FAS | Financial Planning

The Bank of England’s Monetary Policy Committee announcement of a 0.50% base rate hike last week would have been sufficient to cause headline news on its own, given that the increase was the largest single rate rise announced by the Bank for 27 years. However, it was the accompanying gloomy statement by Andrew Bailey, the Bank of England Governor, forecasting a prolonged downturn in the UK economy over the coming 15 months, that drew most attention.

Fifteen months of recession?

Mr Bailey warned that the UK would move into recession in the fourth quarter of 2022. Recessionary conditions represent a significant and prolonged downturn in economic activity, and is often defined by two successive quarters where Gross Domestic Product (GDP) falls. Mr Bailey’s comments that the Bank now forecast a contracting economy for the latter part of this year and for the whole of 2023 raised eyebrows amongst commentators and respected economists. Former Monetary Policy Committee member Professor David Blanchflower commented that Mr Bailey had been guilty of “loose talk” and the day of the announcement was “… as bad a day for the British economy as I can remember”.

The statement by the Bank, which accompanied the 0.50% base rate hike, cited sharply rising inflation over coming months as the reason behind the rate increase. The Bank now expects Consumer Price Inflation (CPI) to reach in excess of 13% later this year, largely due to the increase in wholesale gas costs. This would represent a further increase of 3.6% over the current CPI print.

We take an objective view of macro-economic conditions, and generally feel that central bankers perform a reasonable job, given the intense focus that markets place on every announcement or comment that is made. In this instance, however, we can’t agree with the Bank’s comments in respect of the UK economy, and would go as far as branding the pessimistic long-range forecast as being irresponsible.

Interest rate policy

Firstly, let’s consider the reason behind the rate increase announced by the Bank. Inflationary pressure is largely being caused by external forces that are beyond the control of the Bank of England. Energy and Fuel costs are all increasing as a result of the conflict in Ukraine, which has driven the price of wholesale gas to more than double since the start of the year. Sanctions on Russia, combined with threats to slow or even halt gas supply through pipelines, has led to a scramble to secure gas supplies, pushing prices higher. Crude oil prices have similarly seen a spike during the course of 2022, although prices have fallen back by 25% since the start of June. Food prices have been driven by a combination of increased costs of shipping and transportation, and increased costs and limited supplies of goods such as Sunflower Oil and Wheat.

Despite this Core CPI – which ignores energy, food, alcohol and tobacco prices – has actually fallen back from 6.2% in April to 5.8% in June. Core CPI tends to be a useful measure of domestically generated cost pressure, and perhaps should give the Bank more comfort that wage increases and prices for goods and services are not out of control.

We would argue that the strength of our currency is an area that should command more focus in decision making. Sterling has been weak against the Dollar, falling by more than 10% this year, which stokes inflation, as the cost of imported items priced in Dollars increase as Sterling weakens. Given the immediate reaction on currency exchanges to Mr Bailey’s comments, which saw Sterling weaken in the face of the 0.50% base rate increase (which would normally be seen as positive for the currency) we feel Sterling may remain under pressure for some time to come.

Growth will slow, but perhaps not stall

The dramatic drop in GDP expectations announced by the Bank is another area we feel demands further scrutiny. The Bank’s central forecast is for growth to be negative for the final quarter of 2022 and remain in negative territory for the whole of 2023, with a net contraction of 2.1% over this period. When divided by the five quarters of recession suggested by the Bank, this would represent a contraction of 0.4% per quarter, which is considerably more pessimistic than the OECD (Organisation for Economic Co-operation and Development) which suggested in June that UK growth would be flat during 2023, and the International Monetary Fund (IMF) which, in April, forecast 1.2% growth in 2023.

UK GDP increased by 0.8% in Q1 of 2022, and the preliminary reading for Q2, to be announced next week, is expected to continue to show the UK economy expanded, albeit by a lower rate of growth. April showed a decline of 0.2%, but May saw GDP increase by 0.5%. Given the reported rate of growth, compared to the grim projections by the Bank, growth is either going to slow dramatically, or (as we would suspect) the Bank is being overly negative in their forecasting.

As you can perhaps deduce from our analysis, we don’t agree with the Bank forecasts or the message that the Bank appear to be conveying. We find it hard to believe that Mr Bailey’s predecessors, Mark Carney or Mervyn King, would have made such predictions. It is clear that inflation will persist, although we expect the pressure to ease as we move into 2023. We also appreciate that growth is likely to slow as we move towards the end of the year, although we feel more positive that any recession in the UK will be more short-lived than the Bank suggests.

If you would like to discuss the above with one of our experienced advisers, please get in touch here.

Aug 04

Man looking at stocks and shares on phone and laptop

Investing with conviction

By FAS | Investments

The profit announcements from BP, Shell and others have made headline news over recent weeks, due to concerns over the raising of the energy price cap and hikes in gas and electricity prices to follow in the Autumn. Given the size of the profits generated, and dividends declared to shareholders, it is of little surprise that the Energy sector has been the best performing sector within the UK Equities market over the year to date.

In the first half of 2022, the Energy sector returned 28.2%, a comfortable lead over the next best performing sector, Healthcare, which returned 16.5%. This performance is in stark contrast to the worst performing sectors, Consumer Discretionary (which fell by -21.2%), Industrials (which recorded a 21.9% fall), and Technology which returned -28%.

How an investment fund responds to such disparity of performance across sectors depends on whether an passive or active investment approach is being adopted, and where an active manager is employed, whether a high conviction strategy is used.

The Passive v Active debate

Within a Passive Index fund, which tracks the return of a particular market index, the fund will allocate the portfolio to broadly match the composition of the index. This means that the fund holds representative weights in each sector in line with the weight in the index. So a FTSE100 index fund could hold around 8% of the portfolio in Shell and 3.5% in BP.

The opposite of a passive investment approach is an actively managed fund. When a fund is actively managed, it employs a professional portfolio manager, or team of managers, to decide which underlying investments to choose for its portfolio.

Being actively managed, this would permit the fund management team to allocate funds across different sectors of the index, and depending on the style of the fund, the sector allocation could differ a great deal from the percentage allocations of the benchmark index. These decisions can have a significant impact on fund performance, depending on the level of variance compared to the index composition. For example, an actively managed fund with a lower allocation to the Energy sector during this year would have struggled to keep pace with the index over the course of the year. Similarly, holding too much in Technology, the worst performing sector in the UK over the last year, would also weigh on returns.

Holding the right stocks at the right time

Of course, market conditions continue to evolve and the performance of different sectors of the economy will swing from period to period. Comparing the period from March 2020 to March 2021, to the last year, illustrates this very well. Over the lockdown period, Healthcare was the best performing sector, followed by Basic Materials and Technology, with the Energy sector – which has performed so well recently – lagging the leading sectors by some margin.

The ability of a fund manager to allocate the fund correctly, and make decisions to alter the structure of the portfolio over time, will make a sizeable contribution towards the overall performance. Looking at the Energy sector over the longer term, for example, paints a very different picture to the significant outperformance seen this year. Over the last 10 years, both BP and Shell shares have each lagged the benchmark FTSE100 index by over 30% over this 10 year period. Holding the correct stocks, at the right time, is therefore key to effective active management.

Research is key

When we research investment funds, through data analysis and meetings with leading fund houses, we often come across fund managers and management teams that look to take a so-called “conviction” based approach. This involves constructing a concentrated portfolio of a smaller number of holdings than an average fund would hold, perhaps holding as little as 30 stocks. Holding this number is likely to mean that the manager will be taking a considerable position in certain sectors and holding very little in other sectors of the economy. As demonstrated by the sector data over the course of this year, correctly allocating the portfolio to the right sectors and positions could yield significant outperformance.

Taking the opposite approach, we often review actively managed Equities funds that positions the portfolio with only subtle variance to the representative index. As a result, the performance of these funds tends to hug the index return, and lends predictability to the performance achieved. However, holding this type of fund begs the question whether the investor is getting good value for money from investing in an actively managed fund, when a passive tracker fund could do a similar job for the investor typically at much lower cost.

The average actively managed UK Equity fund will charge an annual management fee of between 0.50% and 1% per annum, which will eat into returns, unless the active manager can generate outperformance that justifies the cost. Compare this to a UK index fund, which can cost as little as 0.06% per annum, and will achieve returns close to those achieved by the benchmark index.

Both passive and actively managed funds do very different jobs in a diversified portfolio of funds, and there are advantages to each approach that merit their inclusion in a chosen strategy. Where fund managers show high conviction, with a good deal of success, this can often easily justify the higher costs due to the outperformance achieved. We are often less impressed with actively managed funds that offer a very similar strategy to a passive approach, but offer the investor poor value for money.

With over 3000 funds available to UK investors, blending funds to achieve good levels of diversification, lower volatility and strong performance can be daunting for private investors. At FAS, we have a disciplined investment selection process, which is designed to select funds with good prospects for outperformance over the longer term. If you hold an investment portfolio currently, speak to one of our experienced Financial Planners to review the performance, risk and value you are receiving.