A Restructure That Reinforces the Importance of Liquidity and Transparency
A couple of weeks ago, in our Blog post: Octopus withdrawal freeze highlights the importance of transparency and liquidity, we wrote about the suspension of withdrawals from the Octopus Inheritance Tax Service (‘OITS’) and the questions it raised around liquidity, transparency and valuation. Octopus has reopened OITS but a substantial proportion of their clients’ money is still unavailable.
Octopus has now announced a restructuring of its Fern Trading company, in which OITS investors hold shares, that will allow partial trading to resume. However, the changes reinforce many of the concerns we highlighted previously regarding liquidity, valuation and transparency. Those investors needing access to cash in the foreseeable future, will be extremely frustrated.
According to Citywire, Octopus is splitting Fern Trading into two separate share classes. Approximately two-thirds of the business, including renewable energy, property lending and housebuilding, will sit within a tradeable “Fern A” share class. The remaining third, consisting largely of the underperforming fibre infrastructure businesses, will be placed into “Fern B” shares, which will not facilitate routine trading or withdrawals.
Reopened… But How Liquid Is It?
Whilst Octopus is reopening trading in Fern A, investors should recognise that around one-third of the original portfolio has effectively been separated into a share class where routine withdrawals are not available.
The ability of investors to withdraw from Fern A also appears to rely on two important assumptions:
- That not all existing investors seek to withdraw capital at the same time.
- That sufficient demand exists from new investors entering the service.
Whilst neither assumption is unusual for structures of this type, the events of recent months demonstrate how quickly liquidity can become a concern when investor sentiment changes. If a significant number of existing investors decide they would like their money back, or if new investment flows slow, questions around liquidity could quickly re-emerge. For this reason, we believe investors should look beyond the headline that Fern has “reopened” and consider how liquidity is expected to function in practice.
For many investors, the key question now becomes:
Has liquidity genuinely returned, or has part of the liquidity challenge simply been isolated within Fern B?
On the surface, investors may welcome the return of some liquidity, although if too many want to exit the A shares, and there are not enough new investors, there could be a situation where Octopus could be obliged to suspend withdrawals from this class as well. As recent events have shown, liquidity should never be assumed. The structure also raises an obvious question:
If these assets are sufficiently problematic to require segregation into a separate, non-tradeable share class, what does that say about the risks that were previously embedded within the portfolio?
As reported by The Times, the fibre businesses had already been written down by £125 million following substantial losses, while Fern itself reported a significant loss last year. The restructuring appears to acknowledge that not all assets within the portfolio are equally liquid, equally transparent or equally attractive.
That is precisely the point we made in our previous article.
Tax Planning Is About More Than Tax
Business Relief remains an extremely valuable Inheritance Tax planning tool. However, successful planning requires investors to look beyond the headline tax benefit and understand the underlying investment structure.
The Fern developments demonstrate why.
Many unlisted Business Relief services invest through complex private company structures where valuations are determined using internal methodologies and liquidity can depend upon the provider’s ability to facilitate transactions. In normal market conditions, this may work perfectly well. But when challenges emerge, investors can discover that access to capital is not as straightforward as they may have assumed.
The recent suspension, followed by the creation of a non-tradeable share class, illustrates the difference between theoretical liquidity and actual liquidity.
Why AIM Remains Different
One of the key points we raised in our earlier Blog was that investors should not confuse lower volatility with lower risk.
Private company investments are not continuously priced by the market, which can create an impression of stability. AIM shares, by contrast, are priced every trading day. That brings greater visible volatility, but it also means investors can see what the market believes their holdings are worth.
AIM also provides greater transparency through published accounts, regulatory announcements and observable market prices, while shares can generally be bought and sold through the stock market.
Qualifying AIM shares are now eligible for 50% Business Relief. While this is lower than the 100% relief available through some other Business Relief investments, recent events are a timely reminder that Inheritance Tax planning should not be judged on the tax saving alone. Liquidity, transparency, valuation and access to capital matter too.
And that is perhaps the clearest contrast highlighted by the events at Fern:
An independently determined market price and genuine liquidity.
To discuss AIM for Inheritance Tax portfolios and whether they may be appropriate for your circumstances, please contact Fundamental Asset Management on 01923 713890 or email [email protected]
