Its Not Harry

Comment and opinion for retail investors in the UK

Mark Potter

Wagging tails but tears to come?

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This blogger does not normally comment on matters relating to tax planning, because although he has multiple appropriate professional qualifications and a lifetime of experience, he would have to admit to being a bit rusty on the rules and regulations!

However, developing media coverage of a firm called Oxford Capital which made what may have been some very adventurous investments in unlisted businesses, some of which appear to have gone pear shaped, prompts me to remind readers not to let ‘the tax tail wag the dog’ as the saying goes.

Financial advisers often look to gain tax planning advantages for clients by investing in portfolios of unlisted company shares (or even individual businesses) where the Government has offered various exemptions to attract risk capital to new ventures.

Two problems usually arise: the investors who are looking to save tax may actually be relatively risk adverse and secondly, the flood of money from tax planning schemes results in the purchase of shares in what might be called ‘daft’ or even contrived busineses. By contrived, I mean set up to match the rules of the tax concession, not to actually develop any new ideas or products.

Tax advantages should not be the cause of poor investment decisions

I recall one 31st March driving late evening past a hilltop in my then home county of Dorset and noticing it was a hive of floodlit activity. I later learned there was a race to finish a solar panel battery by the end of that month so it qualified for specific tax subsidies. It was said that workers had been brought in from Russia to put in the necessary hours!

That really makes the point that operators of schemes, who often take large cuts in fees and commissions, will push the boundaries and not look too hard at what the underlying investments are. Apart from the ethical questions about maximising tax relief for the already rich by claiming subsidies from the general tax budget, such advisers risk losing their clients’ money and possibly even their clients’ reputations.

If you are offered an investment in a ‘safe’ portfolio of unlisted companies, check out what those companies actually do and get a second expert opinion.

‘Buy land – they’re not making it any more!’

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A piece of advice from the ever amusing and perceptive Mark Twain, I believe.

I have recently been looking at model portfolios offered by different investment advisers and funds investing in commercial properties like shopping centres, warehouses and office blocks are pretty much standard components of cautious or defensive models.

When I was in my early 20s and became a pension fund trustee, the pension fund advisers said we needed to buy some property to diversify from our portfolio of fixed income bonds and international equites. I read the proposal and noted that the income yield was about 4.5%. As other fixed income assets were paying about twice that, I could not see the advantages.

What was politely explained to me was that inflation in the early 1980’s was so high that the return on deposits and government bonds was in real terms negative. Because property values went up with inflation, so did the rent over time (unless you had no tenant, of course) and that was the merit of the asset. It was a hedge against inflation.

That is the main theoretical advantage of owning a portfolio of commercial properties. Commercial property has the advantage over private residential property in that the owner has much stronger rights over the tenant and rarely has to meet the cost of repairs, insurance and so on. Leases are also quite long, typically 9 years at least and sometimes much longer. Tenants may be ultra reliable, like banks or government departments.

All asset classes should be bought in the context of the value on offer at the time of purchase.

So financial advisers put property funds in portfolios to get the steady income yield, the inflation proofing over time and there is also a limited degree of diversification.

But, that does not mean they are ‘safe as houses’. Commercial properties do not sell quickly, so such funds have to hold a lot of cash to meet withdrawal requests when people get nervous, or they have to impose restrictions on withdrawals. Holding cash when cash interest rates are low is a drag on performance.

Valuations are also not so frequent, maybe quarterly. And valuation is a matter of opinion if the property is not actually for sale. Comparisons with similar properties are made, so if the market gets into trouble there is contagion.

If valuations go up over a long period and economic factors mean that rents don’t, then yields are said to become ‘compressed’. That is usually a warning that valuations need to come down, because the asset class is becoming less attractive. I have seen that happen several times in my working life – there is a definite cycle.

Tax is an issue too as property fund income is taxable at source unless it is set up as a PAIF (a special type of fund structure) and that is not possible with conventional collective funds, only ISAS, SIPPS and other tax exempt structures. So non-taxpayers will lose 20% of their yield in some cases. After tax and expenses, some well known retail property funds are currently yielding not much over 2%.

With town centre retailers having a hard time, Brexit threatening distribution chains and foreigners not wanting to invest in Britain, the sector faces some tough headwinds. I would be avoiding it for the time being, but will always consider it as a portfolio component when the time is right.

Most investors in Southern England already own plenty of land (in value terms) and live on it!

Slack, bang, wallop?

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Another astonishing new share flotation in the US. A business messaging application called Slack (hardly a great novelty – I can recall various versions of such going back 20 years) has floated and immediately moved to a valuation, based on share price of 25 billion dollars.

This is a business that turns over 400 million dollars and managed to lose more money than its previous year’s turnover. As the BBC explainer on this says, losing money when you start a business is normal (easier when it is someone else’s money, I might add). The BBC refers to the few successes that became worth billions, but in recent examples the valuation is starting at billions, in effect completely discounting any chance to make money like that in the future. The sure fire winners are the founders, who have struck lucky.

The valuation is clearly totally detached from reality and the only other people who will make money are those who resell their initial allocation of shares to those who haven’t got them and want to speculate, at a nice profit. These people only invested to make this resell profit, like ticket touts. They don’t care in the slightest if the underlying business is any good any more than a ticket tout has any interest in the singing merits of Taylor Swift.

At its worst, the stock market makes gambling look logical

This sort of activity has not much direct relevance for investors in retail funds, but when it becomes the norm, one must worry. Why? Because if 25 billion dollars goes into a worthless business and is later lost, the investors in question will sell other assets to balance their books and those sort of sales have a significant negative effect on the market.

And that is not all – a crash in a certain segment of the market can be the start of a domino effect, because the market mood changes and FOMO (fear of missing out) is substituted by a rush for the emergency exits.

If you have big profits in tech funds, now might be the time to think about securing them!