Collective Investment Schemes are commonplace in UK investment management and are the overwhelming choice for UK retail investors for use within their ISA and SIPP tax-wrappers when looking for exposure to UK smaller companies. But are they all that they seem and are they the only choice? Models of directly held equities are often overlooked but investors could be missing out on the added value models bring over collective investment schemes.

UK smaller companies prove themselves to be big outperformers on the global stage

Texas based fund manager Alta Fox, published an analysis of the best performing small-listed companies in the developed world. This was over the five years from 2015-20 and companies were required to have positive revenue growth and earnings before taxation, interest and depreciation for the previous 12 months. This included companies in North America, western Europe and Australia valued at $150m- $10bn, and that had generated a total shareholder return of at least 350% over the five-year period (35% a year compounded). It excluded all companies in the energy, materials and financials sectors.

Of the 104 companies to make the final cut, 55.7% were from Western Europe vs 32.7% from North America. 13.46% of the top performing companies were found on AIM while only 2.88% were on the UK Main Market. 21.15% were on the Nasdaq, with technology overall making up only 34% of the total.

US companies made up 28.8% of the total, with the UK in second place with 15.4%.

You can hear more about the outperformance of AIM from our CPD adviser webinar session: Is AIM heading for a fall… or is its outperformance set to continue?

Key benefits

Model portfolios give you full visibility and knowledge of all holdings, not simply the ‘Top 10’. This means you can see exactly what you are investing in.

Portfolios of shares are priced at the market price of the underlying holdings and most closed ended small/micro-cap funds trade at a discount to net assets (discounts typically widen during market sell-off), some as high as 19%.

The nature of segregated portfolios of shares means individual investors interests are not bundled with those of others. They therefore benefit from greater liquidity, an ability to sell when needed. Open ended funds holding small-cap shares are very hard to manage given the fluid nature of subscriptions and redemptions. During market sell-offs fund managers will be struggling to manage redemptions which will require them to sell holdings, thereby exacerbating share price declines.

Liquidity is an important investment fundamental not to be over looked. The illiquid nature of small cap holdings worsened the return for holders of Woodford’s fund and ultimately enforced its closure.

Low Costs

Direct equity portfolios standard management fee is around 1%, often less for larger accounts. On top of this, portfolios do not charge often sizable performance fees and trading costs, notably on adviser wrap platforms, are extremely low.

The cost of running closed ended funds with a focus on small caps is very high, with the Total Expense Ratio (‘TER’) of those we have seen ranging from 1.34% to as much as 7.50% where a performance fee has been charged.

Stated fund TERs also ignore the impact of trading costs. Venture Capital Trusts with a focus on AIM quoted companies also trade at discount with high TERs and performance fees.

Direct equity portfolios managed on behalf of individual clients can easily acquire positions in smaller companies. Closed-ended small cap funds struggle to pick up positions of size in their target investments.

Direct equity investment via portfolios encourages efficient portfolio structure and the avoidance of over-diversification. Open-ended small cap funds are often over-diversified, holding hundreds of positions. This is often due to the less liquid nature of smaller quoted companies

One popular Investment Trust we have come across has 360 different company holdings, with the top 10 only accounting for 17% of net assets.

And finally…..

UK investors in collective investment schemes (funds/investment trusts/VCTs) holding AIM shares don’t benefit from the tax advantages available to those UK investors having direct holdings in the companies.

You can find out more about the benefits of investing in AIM for IHT planning purposes in our free report available from the link here.

Disadvantages

• The management of capital gains is harder via a segregated portfolio.
• It’s much harder to judge performance
• Segregated portfolios can be prohibitively costly for smaller accounts of less than £40k

The Fundamental AIM IHT Portfolio is a discretionary investment management service where clients can obtain 100% mitigation from Inheritance Tax, benefit from the capital growth afforded by the AIM market and retain control of their assets.

You can find out more about Fundamental Asset Management’s high performing AIM IHT ISA and AIM Inheritance Tax portfolio service, which has been delivering exceptional investment returns for more than 17 years, from the link here.

According to The Openwork Partnership, one of the UK’s largest networks of financial advisers, there was a 38% spike in demand for advice on Inheritance Tax (IHT) planning in the past year, with more than one in ten clients wanting to discuss it. This demand is set to increase significantly with latest data from HMRC showing IHT receipts for April to July 2021 of £2.1billion, £500million higher than the same period a year earlier. This is good news for the UK government which is looking at ways of paying for a generous furlough scheme and other Covid-19 support measures. It is however bad news for those looking to reduce IHT, as any increase in IHT tax receipts for the government has a knock-on effect of reducing the amount of assets left to loved ones.

In the Spring Budget, the Chancellor of the Exchequer, Rishi Sunak, announced that the Lifetime Pension Allowance (LPA), nil-rate band (NRB) and residential nil-rate band (RNRB) will be frozen until April 2026. This means the LPA will remain at £1.0731m, the NRB at £325,000 and the RNRB at £175,000 during this time.

In practice, more and more people will find themselves with an IHT issue as asset prices rise with inflation, but IHT allowances remain fixed. House prices alone saw a 2.1% month-on-month increase in August, the second biggest gain in 15 years. This is a key factor helping to explain the sudden popularity of IHT planning by clients and the increase in use of IHT efficient investment products.

You can find out more about the benefits of investing in AIM for IHT planning purposes in our free report available from the link here.

The Office for Budget Responsibility (OBR) is predicting that the next two years may see a slight decline in IHT receipts, due to the effects of the pandemic. That said, they expect the changes made in the budget will see the Government collect an extra £450 million pounds in IHT by 2025/26.

To encourage investors to support smaller growth businesses, the government offers a tax relief called Business Relief (BR). Many companies can qualify for this tax relief, including many companies listed on AIM. Once shares in qualifying companies have been owned for a minimum of two years and until the point of death, the shares are free from IHT. Furthermore, since 2013, AIM shares can be held in an ISA which means that investors can enjoy tax free growth and income on any gains made. This means that investors holding BR-qualifying AIM shares within an ISA can create a tax-efficient investment with no Income Tax, Capital Gains Tax or Inheritance Tax.

Want to hear more? Join us at 2pm on Wednesday 15^th September for our upcoming CPD Adviser webinar session- How can AIM help your clients’ Inheritance Tax planning?  

The Fundamental AIM IHT Portfolio is a discretionary investment management service where clients can obtain 100% mitigation from Inheritance Tax, benefit from the capital growth afforded by the AIM market and retain control of their assets.

You can find out more about Fundamental Asset Management’s high performing AIM IHT ISA and AIM Inheritance Tax portfolio service, which has been delivering exceptional investment returns for more than 17 years, from the link here.