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Mike Senior, Business Development Director, interviews Jon Gould, AIM IHT Lead Portfolio Manager, to discuss the AIM market in terms of Inheritance Tax planning, common misconceptions and myths, AIM-associated risks and typical planning scenarios.
|0:50 Intro to Jon Gould
1:26 Business Relief for estate planning
2:48 AIM Market introduction
4:12 AIM companies that don’t qualify
6:18 AIM companies that are eligible
7:48 Sensible starting point to build an AIM portfolio for estate planning
11:13 Common myth: unprofitable businesses and penny shares
|15:15 AIM market compared to other UK indices
18:46 Business Relief, and the consequences if the rules changed
22:23 Typical planning scenarios
25:11 What make’s Psigma’s service different?
27:18 Typical number of stocks in the portfolio
29:13 Typical average client investment
30:10 Importance of working alongside an advisory partner
Mike S: Hello, and welcome to an Investment podcast brought to you by Psigma Investment Management. I’m Mike Senior, a Business Development Director at Psigma. In this podcast I interviewed our AIM IHT lead portfolio manager, Jon Gould, to discuss how investing in the AIM market is used for Inheritance Tax Planning. Main topics we discussed included an overview of Business Relief and the AIM market, common misconceptions and myths, risks to be aware of, typical planning scenarios and how Jon manages Psigma’s approach.
To save the need for making any notes whilst listening, we’ve provided time specific pointers to accompany the recording.
It’s also important to note that what we did talk about isn’t in any way a personal recommendation.
So, without further ado, here is the interview.
So, Jon before we kick things off, can you give us a brief introduction to yourself, and how you have come about being Psigma’s AIM IHT lead portfolio manager?
Jon G: Yes – I joined Psigma as part of the acquisition of AXA Framlington’s private client department in 2013. Both here and at my previous firm I have been responsible for managing predominantly UK equity portfolios for private clients, of which AIM is a crucial part. We brought the AIM IHT Service across with us, so I have been leading the proposition here since we arrived just over seven years ago now.
Mike S: For those listeners who are new to this area, perhaps you could start by giving us a bit of background to Business Relief and why it can be a useful tool for estate planning.
Jon G: Absolutely. So Business Relief, or Business Property Relief as it used to be known, has actually been around since the mid ’70s, and essentially it allows certain assets to be excluded from your estate for inheritance tax purposes. So long as the asset qualifies and has been held for at least two years on the date of death, the value of that investment is no longer subject to inheritance tax.
When it was launched in the ’70s, it was designed to allow family-owned, unquoted, private businesses to be passed on to the next generation without having to be broken up or sold to settle a tax bill. But over the years various governments have recognized that the advantages of this aren’t limited to family-owned businesses, and so the relief has extended to other unquoted trading companies too.
40 years on and it is still seen as an important tool for encouraging investment in growing companies.
Now, one of the main attractions of Business Relief is that two-year holding period. So from a timeline perspective, it can compare quite favourably to other estate planning tools.
Mike S: Okay, so what is the AIM Market then, and how does that fit in?
Jon G: Well, the AIM market is a sub-market of the London stock exchange, so it is not part of the main list that includes FTSE 100, 250 or small cap index, even though some of the companies on AIM are big enough to be considered for FTSE 100 or 250.
The AIM Market itself was launched in 1995 with 10 companies and a combined market value of about £80m. Today we’re heading towards 850 companies with market cap of +£104bn, so it really has come a long way over the last 25 years and remains an important source of capital for businesses where debt financing is expensive, difficult or just inappropriate for the business.
So how does Business Relief fit into this? Well, generally speaking, the regulatory requirements to list on AIM are less onerous than they are on the main list – the listing fees are a bit cheaper, you don’t need quite as much trading history, for example – so for a lot of small and medium-sized growth companies it has been quite an attractive place to list to raise finance. But because they are not on the ‘main list’, so to speak, they are deemed to be ‘unquoted’, and so Business Relief can be eligible on selected AIM listed companies, but not all.
Mike S: Ah, okay, so you say not all AIM listed companies are eligible for Business Relief. Can you talk a little bit more about that?
Jon G: Of course. So obviously the rules around Business Relief can be quite complex so I won’t get bogged down here. We use PWC to give us ongoing advice on this, but as a general guide it’s worth thinking about it from the perspective of what the government is trying to achieve. They are trying to encourage investment into trading or operating businesses, companies that produce a good or a service, that employ people, and ultimately make a positive contribution to the economy.
So things like investment trusts don’t qualify, for example, as an investment trust could list on AIM but actually the underlying investments may be in the FTSE 100 or overseas, which is not really an area of the market that needs much help.
Similarly, real estate investment trusts (REITs) don’t qualify, but by extension actually any company with a lot of land on the balance sheet doesn’t tend to qualify either. This is generally because ‘land’ is not really seen as a ‘business’ – it doesn’t employ people or produce anything, but it does tend to hold its value over time. Now, a company might have a very small operation but a very large land investment, and clearly the share price will be more closely aligned with that land value than it would be the operating part of the business, so as a general rule, anything with a lot of land that isn’t being used for business purposes tends to be excluded.
This is one of the reasons why a lot of oil and gas, mining and resources companies are not eligible, because obviously they own quite a lot of land to drill on in future. But actually, this does us a bit of a favour as a typical AIM IHT portfolio will naturally avoid what is a very cyclical and volatile part of the market.
Mike S: Right, so what about the things that are eligible – once it qualifies, does it continue to qualify? How does that work?
Jon G: No, and that’s an important point. The HMRC doesn’t provide a list of eligible investments because ultimately it depends on what the business looks like on the date of death. A potentially eligible investment today may not be eligible if they change their business model to something that doesn’t qualify by the time of death.
The advantage we have is that we do not have to stick with the same investments throughout the lifetime of the portfolio. We can sell an eligible investment and reinvest in another and the two-year clock isn’t restarted.
This applies more broadly as well, so a lot of our clients may have sold a private or family owned business that was eligible for Business Relief, and if they reinvest the proceeds of that within a certain time frame, that Business Relief carries on.
Mike S: Following on from that, if a typical retail client was looking to hold a portfolio of AIM stocks as part of their estate planning strategy, what criteria do you think would be sensible as a starting point?
Jon G: So, I can tell you how we look at it. Obviously we can’t give any personal recommendations here, but I think a Business Relief portfolio requires a slightly different way of thinking to other equity portfolios. The way we’ve always approached our AIM portfolios is to first recognise that your typical AIM IHT client is not your typical smaller company investor – the objectives are slightly different. Our clients might not be natural born risk takers. They accept risk that comes with AIM investment because they have to, not because they want to necessarily, and so that does influence how we look to construct the portfolio and the sort of businesses we invest in.
So with that in mind, the way I would describe it is that we’re not starting out by looking for the companies we think are most likely to quadruple, but actually the reverse; we’re really looking for the companies we think are least likely to halve. Of course, that’s not to say we don’t find companies that quadruple, or companies that halve from time to time, but I think this slightly different way of approaching it should provide a good foundation for any Business Relief portfolio.
So what sort of companies provide that sort of resilience? Well, to me it’s companies that are established and profitable. We’re not looking for speculative companies that may or may not be profitable in three years’ time: we want a business that has a track record and trading history. A strong balance sheet is crucial, as you want the management team to be working for the benefit of the equity holders, not the debt holders, but also visible and repeatable revenues, earnings and cash flow – we want to find businesses that have a reliable earnings stream from year to year.
But overlaying this, we are looking for companies that can grow sustainably over time, so we’re looking for businesses that are enjoying a structural tailwind, be it in a particular niche product that saves cost or adds genuine value to their customers, or a broader industry-specific theme, like cyber security, online education, or shifts in consumer behaviour.
I suppose what you’re trying to avoid is a portfolio that is purely reliant on continued economic growth. An economic tailwind is helpful, of course, but when it turns, you want other growth drivers at play to help mitigate the headwinds.
Mike S: One of the pushbacks I get from planners is a perception that the AIM market is full of unprofitable businesses or penny shares. Does the AIM market provide you with enough opportunity to find the sorts of companies you want?
Jon G: Yes, I hear this a lot too and I think that’s slightly outdated now. A lot of people don’t realise how much the quality of the index has improved over the last 10-15 years.
This has been through a number of factors, really. Firstly, the companies with no earnings or unsustainably high leverage tend to get themselves into trouble in time, so we’ve seen a lot of the lower-quality companies drop out of the index. But we’ve also seen more companies choose to join AIM, and crucially more companies decide to stay on.
Now, there’s no automatic promotion from AIM. So, it’s not like when you reach a certain size you have to go and list on the main list. So really, it’s a choice for the board, and we’re seeing more and more companies choosing to stay on AIM. This is for a variety of reasons I think, but a large part of it is that there are few disadvantages of being on AIM now. 15 years ago, it was perhaps looked down upon, your shares might not have any liquidity or be valued at a discount to your peer group, but that’s not really the case anymore. So, in many cases there isn’t the incentive to jump up. There’s the cost implication too, as a main market listing costs more in listing, legal and reporting fees.
But I think one of the most powerful incentives for companies to remain on AIM is that management have usually built up shareholdings in their business over the years, and have their own IHT liability to consider.
Mike S: Interesting – I was going to also ask about liquidity, but it sounds like that has been improving as the index has matured?
Jon G: Yes, I would agree with that. But it’s also important to remember that liquidity is a function of size, so what’s liquid to us looking after just over £50m in the AIM IHT market is very different to a manager looking after £1bn plus.
If we’re taking a new position in a company or exiting an investment, our trade size may be a couple of million pounds. It depends on the company, of course, but if that company is £500m in size, £2m is reasonably easy to trade. It’s very different when you’re trying to trade £20m, for example.
Now, the advantage that this gives us is that we have fewer liquidity constraints and so can actively look for smaller companies that are below the radar of some of the larger investment houses. Our sweet spot over the years has been companies valued at £200-£400m, and holding them until they get picked up and bought by the broader investment community.
Mike S: Compared to other UK indices, how would a typical AIM IHT portfolio compare in risk and volatility?
Jon G: It’s probably worth answering this by highlighting that all equity investments should be considered higher risk. The longer time horizon you have the more that risk is mitigated, but clearly they can be volatile in between, and an AIM investor might not have a 20-year time horizon.
Smaller companies in general should be seen as higher risk as they tend not to have the same benefits of scale or diversification that a FTSE 100 company might do, so the share prices do tend to be more sensitive to investor sentiment and economic cycles.
The flipside to this is that there are also opportunities. Smaller companies should be more nimble and better placed to react quickly to opportunities and threats. They can tap growth opportunities that might be too small for a larger company to compete for seriously but might be a big opportunity for the smaller company. Modest market share gains can also have a significant impact on a smaller company’s profitability. So, in theory, a smaller company should still have prospects and opportunities to grow even in a benign economic environment.
Now, in terms of whether that risk is appropriate for you as an individual, that’s really where your financial adviser will come in, and they can guide through the implications of what it means for their overall risk profile. If necessary, they can adjust or compensate by de-risking other assets.
I have found that it doesn’t often require a drastic restructuring though, for two main reasons. The first is that a lot of clients simply fund the AIM portfolio from existing equity investments – from a risk profile perspective, switching FTSE 100 or overseas equity into AIM equity isn’t quite a big a step change as it would be going from cash into AIM.
Secondly, the risks of investing in AIM should also be considered alongside the risks of not investing in AIM. If you have cash that is surplus to requirements and intended to be handed down to the next generation, then you face losing 40% on an IHT bill anyway, so the downside you would need see in the portfolio before you are worse off provides a bit of a cushion, and some compensation for the higher risk they are taking.
Mike S: Thanks Jon. One of the questions I most frequently get asked by advisers is around the future of Business Relief, and the consequences if the rules changed. Could you give us some thoughts around that?
Jon G: Yes, it’s been a risk that has been there certainly for the last 12 years I’ve been involved in managing these portfolios. There’s always a risk that tax rules can change in future, but what I would say is the arguments for and against ongoing business relief is a little bit more balanced than it might first appear. I think the harshest critics will always point at it being a tax break for the rich and that the amount of relief given could be better used by the Treasury elsewhere. However, the amount of tax relief that the Treasury gives for Business Relief specifically is relatively small in the grand scheme of things; the last figures that we have show that it’s only about £600 million that the Treasury gives for business relief. Now that sounds like a lot, but it’s relatively small or modest in comparison to the £9 billion or so that passes on tax-free between spouses, for example.
The broader benefit that isn’t talked about much is the positive contribution that AIM listed companies make to the UK economy. There was an interesting study published by Grant Thornton that calculates that AIM listed companies contributed about £33.5 billion to Gross Value Added to UK GDP last year, and directly reported 450,000 jobs. So, whilst I cannot sit here and predict what this or future governments might do in tax rules in the future, I don’t think it’s quite as straightforward as getting a quick and easy boost to tax receipts; there are other benefits and drawbacks to consider.
But I think with that said, we do look at this portfolio as proper investment portfolio, so with all of the companies that we invest in are there for investment reasons; it’s not just there for tax relief, and that’s sort of how the AIM service started. When I was at my previous firm, we opened the first AIM IHT portfolio in 2006 and we stumbled across it by accident. As part of a normal multi-cap UK equity offering, we would often find we had AIM listed companies within that for investment reasons, not tax reasons. However, as tax relief became better understood by both ourselves and our clients, it made sense for us to hive off the AIM listed shares in a stand-alone portfolio. But I suppose the overriding point there is that those companies were there for investment reasons, and that continues to this day; so we own a lot of the shares that we own in the AIM portfolios in non IHT mandates. I think that is a testament to the investment prospects that we see for those individual companies, and it’s not just there for tax. So if Business Relief does change in future, then hopefully we are not left with a portfolio that is purely there based on tax relief and that it can be seen as an investment portfolio as well.
Mike S: Okay, we’ve covered quite a lot there in terms of what Business Relief is, how it relates to the AIM market and how it could be of use within a client’s overall financial plan.
In your experience, what are the typical planning scenarios you most often come across?
Jon G: I mentioned earlier that Business Relief and the AIM two-year time horizon compares quite favourably to other forms of estate planning tools, and its not an “either or”. A lot of our clients will have other estate planning solutions in play, and the AIM portfolio is a part of that overall plan, but the two-year clock does compare quite favourably. Death planning is an awkward conversation to have between planners and clients in general, so we find quite a lot of people leave it quite late; in that regard having a two-year time horizon is a bit more favourable than other solutions.
But I think one of the main attractions for a lot of clients is that they retain control: it works like any normal discretionary portfolio, except you are just invested in a particular type of asset. However, you can have your money back at any point: you can withdraw money, you can add money, and it can remain in your name. We have some clients who are reluctant to let the next generation know how much money they have, and so an AIM portfolio ticks a box for them because the next generation wouldn’t necessarily find out about it until that sad day comes. So the control element is quite a large positive for the AIM portfolio.
In terms of other planning scenarios, we’ve come across a number of clients who have built quite large ISA portfolios over the years. It’s important to remember that ISAs are very tax efficient in life, but the ISA forms part of your estate just like any other asset after you pass away and would be subject to inheritance tax. So where clients have built up a large ISA portfolio they are unlikely to ever need to draw down on, we have seen a lot of those ISAs be converted to AIM ISAs, and since 2013 we’ve been allowed to buy AIM listed shares within ISA portfolios. So that has been quite a neat tool for a number of clients to utilise those ISAs which would otherwise be part of their estate.
Mike S: That’s great, thanks Jon – it sounds like there are lots of opportunities to use an AIM portfolio for planning in this area.
When an adviser then moves on to research this market, there are some excellent tools out there such as MICAP to help them get from many to a few. If Psigma feature on a shortlist, what in your opinion are key benefits that make Psigma different?
Jon G: Good question – I guess one of the increasingly important things in this space is overall cost. I believe we have one of the most competitive fee structures in the market. We do not charge trading fees or entry or exit charges: it is just a straight forward annual management fee plus VAT. We pride ourselves on being clear and transparent.
We also recognise each client is an individual. So whilst we have a strict buy list of what we can buy and sell, we do take each clients individual circumstances into account, whether that’s CGT planning throughout the year, or if the client wants to take an income on a monthly or quarterly basis. The income of the AIM portfolio is never huge, but it does give some flexibility. There is also direct access to the Investment Manager who is going out, seeing the companies and putting them within the portfolio. I think it’s that personalised approach at a reasonable cost that sets us apart from the other standardised portfolios (maybe ‘a lot of the competition’).
Then finally, I would say our reasonably small size. £50million sounds like a lot of money to most people, but in the grand scheme of the investment world it’s pretty small and nimble, and that gives us more flexibility and optionality than a lot of the larger players out there that can struggle with liquidity sometimes.
Mike S: Considering the amount of money you do manage, roughly how many companies do you look to own in the portfolio?
Jon G: We’ve got 27 at the moment; in fairness, it has always been around that level. We have guided clients and investors to expect somewhere between 20 to 30 holdings, and I think when we first started out (the first portfolio was opened in 2006) we had closer to 20 holdings. However, over the years the increase in the quality and options has created a constant contention for places within the portfolio, so we have been able to extend that list out a bit. In terms of new companies added or removed, we do not tend to swap and change the portfolio too much. We might add one to three holdings each year and take one to three holdings out each year. But a lot of the portfolio turnover, or changes that we make to the portfolio, is just actively monitoring individual positions. The AIM market is volatile and individual share prices can be volatile; we recognise that even if the long-term investment case remains intact and unchanged, individual share prices can get overbought and oversold. So as long as the longer-term outlet hasn’t changed and we still see value in the shares, we just maintain a discipline of taking profits where it is appropriate to do so, and have the conviction to top up core holdings if they have gone through a period of softer trading. So overall, in terms of portfolio turnover, we do actively manage these portfolios but in terms of new positions coming in and exiting the portfolio, it’s relatively low.
Mike S: Okay. Now I know all client scenarios are different, but has there been a typical, average client investment that’s been placed with you?
Jon G: Yes, it’s been broadly the same over the years, with our average portfolio size starting typically at around £250,000, but our minimum is £100,000, so we have a few people at that lower end. A lot of people decide to start with £100,000 and then add ISA contributions each year to it. The average portfolio size now is about £350,000 from the last set of figures I have, but that includes portfolios that are worth many millions as well as other portfolios closer to £100,000, so it is actually quite a broad range.
Mike S: Great, thanks Jon. Just a final question – how important is it to work alongside an advisory partner with AIM IHT Planning?
Jon G: Very important, Mike – I think the importance of having a broad plan and a broad strategy cannot be underplayed here. I can sit here and extol the virtues of an AIM portfolio, but for some people there might be really easy solutions that they haven’t thought about that they can pursue first, which might mean they don’t need an AIM portfolio. A financial planner will really help you identify all potential options and come up with a plan that is right for you. An AIM portfolio might play no part, a small part or a rather large part of that, but it’s important to get the proper advice in the first place.
Mike S: Thanks Jon. I think that’s been a very useful summary of Business Relief, how it relates to the AIM market, key benefits and risks, and how you have developed Psigma’s service.
We’d be delighted to discuss anything we have talked about in this recording further. If you don’t already have a named Psigma business development contact, please email firstname.lastname@example.org. You can also find out more information on our main website.
But for now, that’s it from me and thanks again Jon.
This communication is prepared for general circulation and is intended to provide information only. The information contained within this communication has been obtained from industry sources that we believe to be reliable and accurate at the time of writing. It is not intended to be construed as a solicitation for the sale of any particular investment nor as investment advice and does not have regard to the specific investment objectives, financial situation, capacity for loss, and particular needs of any person to whom it is presented. The investments contained in this communication may not be suitable for all investors. Prospective investors should consider carefully whether any of the investments contained in this communication are suitable for them in light of their circumstances and financial resources.
If you are in any doubt whether any of the investments contained in this communication are suitable, you should seek further appropriate advice.
Psigma’s AIM IHT Portfolio should be regarded as a higher risk, long-term investment. Also please be aware that a portfolio of this type may not be suitable for all investors:
- The tax relief available may change at any time. Psigma receives independent advice from a leading firm of auditors prior to making an investment and our holdings are reviewed on an annual ongoing basis. Each company’s eligibility for business relief is subject to HMRC approval at the time of death.
- AIM company shares can be less liquid than their larger counterparts in the FTSE 100 and 250 indices. In certain situations, it may be difficult to sell or obtain fair value of a particular investment quickly.
- Many AIM quoted companies have smaller management teams and, as such, the loss of any one individual may have a material impact on the prospects of a company. In a similar vein, some companies may have fewer product ranges or a more concentrated customer base, which could potentially leave them more vulnerable to sudden changes in market conditions.
- An AIM quoted company may elect to move to the main market or de-list from AIM, in which case BR would no longer be available. In such a scenario, we would be required to sell the holding and reinvest into another potentially qualifying investment in order to maintain BR status. This may result in a capital gain or loss being crystalised which may not have otherwise occurred without BR being a key consideration.
- You should only invest in the Psigma AIM IHT Portfolio if you have financial security independent of any investment made.
- Psigma also does not guarantee the timescale for fully investing portfolios or that portfolios will be fully invested at all times in the future.
- Potential investors should be aware that tax rules are subject to change. In order to ensure that the Psigma AIM IHT Portfolio is suitable for you, you should take advice from a Professional Adviser.