Marginal Gain – October 2019

So, is this the month that we finally get BREXIT? It would be good to finally get it out the way if only for the simple reason that the rest of Government has been paralysed and inconsequential. Even the new chancellor Sajid Javid while announcing the date for the Autumn Statement and Budget on the 6th November placed that caveat “unless there’s a no-deal”.

Anyway, life goes on and we look at a number of key issues and trends that the current pension legislation has thrown up, where our regulator (FCA) is looking to protect clients and an often-overlooked aspect of a Will – guardianship. Wills are not just for old people contemplating their own mortality! Finally, an investment commentary from one of our investment management partners – Brooks MacDonald, who have performed above average over the past 12-18 months.

As usual, if anything grabs your attention just drop a line to the author.

The rise of Tax Reducers

Following on from our article last month on the paralysis of the UK pension rules, we look at the alternatives available.

Plans unveiled by the Treasury and Department of Health and Social Care will see a consultation carried out on the annual allowance taper for “top doctors, surgeons and other high-earning clinicians”. Ostensibly, this is designed to allow more top doctors to take on overtime without worrying that they will breach their pensions limit and end up paying more tax as a result. However, this feels like a sticking plaster solution to a shortage of clinicians, rather than a considered policy response to a taxation and pensions issue.

For a start, why should “top doctors, surgeons and other high-earning clinicians” be singled out for special treatment here? The government does seem to have tried to address this by pledging a wider review: “Alongside the proposals for full flexibility, HM Treasury will review how the tapered annual allowance supports the delivery of public services such as the NHS.”

Any changes to the annual allowance taper would have some unintended consequences. Its introduction in April 2016 has been credited with helping to increase alternative tax efficient investments such a Venture Capital Trusts (VCTs) and the Enterprise Investment Scheme (EIS), as those reaching their limits look around for other places to grow their money in a tax efficient way.

The graphs below seem to support this, showing the amount of funds raised by VCTs and EISs since the introduction of the taper has increased – significantly in the case of VCTs and enough to halt a downward trend in the EIS sector. While the taper is not the only reason behind these increases, its introduction for the 2016-17 tax year will have helped the direction of travel.


Removing the annual allowance taper for some high earners would therefore take away one incentive for those people to consider VCT and EIS investments.

While the tax incentives should never be the only consideration for an investment, the taper has been part of the equation when investors look for tax efficient options.

While the growth of EIS and VCT investments in the wake of the annual allowance taper’s introduction may itself be considered an unintended consequence of the government’s tax policy, removing that incentive to invest in growth businesses feels somewhat incongruous as we head towards Brexit and at a time when championing British businesses is a key part of Johnson’s platform. Its removal wouldn’t be critical to these schemes, but it also wouldn’t help grow investment into small businesses.

A VCT and EIS are tax reducers i.e. they reduce the tax you have paid whereas a pension gives you tax relief on the contribution, but when benefits are drawn, income tax is reclaimed on the income (after the tax-free lump sum).

So, the tax implications are different for HMRC and so again, no doubt some think tank is considering the optimum way to encourage investment in UK PLC but equally protecting the cashflow of the Treasury. The consensus is calling for the abolition of the taper with the quid pro quo being a reduction in the tax relief available to maybe a flat 25%. Interestingly, this latter suggestion could, in fact, increase investment into EIS and VCT schemes with income tax relief at 30%!

Jonathan HowardAuthor: Jonathan Howard
Jonathan@carneliancapital.co.uk
01908 487531 #6

Brooks MacDonald Asset Allocation Overview

The US economy’s expansion is now the longest in history, but the expansion has progressed at a slow pace relative to past cycles. We expect the current cycle to extend further, with the economy’s large service sector continuing to grow amid robust domestic consumption and despite the fact that manufacturing activity is being held back by weak sentiment associated with trade protectionism. In line with this, we do not expect an imminent US recession, even if sporadic inversions in parts of the treasury yield curve are indicating that one may be forthcoming; we note that central bank policy may have distorted this forward-looking indicator of recession. Our growth thesis is further supported by the Federal Reserve’s (Fed) recent shift towards a more supportive bias, as well as the fact that US corporate performance is exceeding cautious expectations, even if it has moderated from very strong levels in recent years.

While we are sanguine about the prospects for the US economy, we hold some concerns over the sustainability of growth more globally. The export-dependent eurozone and Japanese economies have been hit far more heavily than the US by the global manufacturing recession and we are concerned that weakness in their manufacturing sectors could spread into their service sectors by undermining domestic demand. Both economies appear to have become growth takers, dependent on external factors rather than their own internal momentum. Despite the ECB’s recently implemented stimulus, we remain sceptical over its underlying countries’ governments’ propensity and ability to boost growth with fiscal spending, particularly in the key economy of Germany. As such, we remain particularly concerned about Europe’s outlook, given recent political developments and the weakness of corporate earnings; the region represents one of our key underweight equity positions.

Meanwhile, in China, forward-looking indicators show that fears of a non-resolution of the ongoing trade dispute with the US are impacting business sentiment at a time when external demand is already subdued. It is arguable that this indirect growth headwind is more potent than the direct measures of tariffs and other restrictions enacted by the US. While growth pressures should therefore remain in the second half of the year, we expect China’s authorities to continue to act to provide stability to the domestic economy, as evidenced by the People’s Bank of China’s recent decision to cut its reserve requirement ratio. We take encouragement from the fact that the government also appears ready to use fiscal stimulus to ensure that the economy meets its GDP growth-rate target of 6.0-6.5%. By supporting its own growth rate, China’s actions should support growth throughout the broader Asian region.

In the UK and for investors in UK assets, Brexit remains the key risk. The UK is set to leave the EU on 31 October and a deal appears unlikely at this stage, given the Government’s demands for a re-negotiated Withdrawal Agreement. The new Prime Minister, Boris Johnson, continues to assert that the UK will leave the EU on this date without a deal if one cannot be reached, but Parliament has moved to make leaving without a deal illegal. It therefore remains highly uncertain how the situation will play out in the coming months. If a deal proves elusive and the Prime Minister cannot force a no-deal secession on 31 October, the chance of a general election will increase. The results of the recent local elections have showed the adverse effect that Brexit has had on the popularity of the Conservative and Labour parties and a general election would likely result in another hung parliament. Despite intermittent relief rallies, the situation continues to weigh on UK assets, including sterling, and we remain cautious on these, holding below-benchmark exposure. Within our UK exposure, we have tilted our position towards large-cap multinationals with low exposure to binary Brexit risks; there will be a point at which UK asset valuations become compelling on a longer-term basis and we are monitoring the situation closely with a view to further reducing our underweight, particularly in UK-focused companies, as and when necessary.

It is fortunate that the global inflationary backdrop has so far remained benign, as this has allowed the world’s major central banks to move to more supportive monetary policy stances. In the US, the Fed has indicated that it is willing to cut interest rates if warranted and has stopped actively reducing the size of its balance sheet via asset sales. In Europe, the central bank has announced an ongoing asset purchase programme, as well as further interest rates cuts and a tiered deposit rate system to help alleviate the pressure that negative rates are having on the banking sector. Meanwhile, the Bank of Japan retains a highly expansionist policy stance, not least to ensure that the yen remains weak. We are watching key inflation data closely, particularly in the US, for signs that the backdrop is becoming less accommodative of easy monetary policy; this is one of our key investment risks.

The shift towards expectations of more supportive monetary policy has been the key proponent of this year’s market rally, not least because it has quelled fears of tightening liquidity that drove the broad market sell-off of late 2018. Equity valuations have become elevated in areas and sovereign yields have been further supressed by monetary policy announcements in recent months. Core regional equity earnings yields remain well above those of equivalent government bonds and we therefore continue to favour equities over fixed income. Nevertheless, we are monitoring businesses’ operating margins closely for any signs a deteriorating economic backdrop is having a more protracted impact on corporate performance.

In any case, we believe it is possible that a mid-cycle correction could occur in the near term.. Nevertheless, we would expect equity markets to find support during such a scenario, given that the economy continues to perform well against an accommodative Fed policy backdrop. We would therefore look to add equity exposure selectively in the event of a market sell-off, notwithstanding any significant deterioration in the macroeconomic backdrop.

We have reduced equity risk in recent months given the threats to the near term outlook. This has involved taking profits in certain investments that have performed strongly, such as international equities, and limiting our European equity exposure. We remain more constructive on Far East equities, where valuations are attractive given the longer-term growth potential and capacity for economic stimulus within the region. Within fixed income, we are avoiding exposure to vulnerable areas of credit markets that could be hit by a combination of slower growth and lower market liquidity, such as high yield bonds. More broadly, we continue to endorse a balanced approach to portfolio construction, utilising income-producing alternative and structured-return assets to increase portfolio diversification; indeed, we have increased exposure to those areas in recent months. Our relative overweight cash positions allow us the opportunity to take advantage of any market correction should we wish.

Pension Freedoms and Regulatory Failures

Official data tells us that almost a million people are going to reach age 55 next year and be able to access their pensions.

Pension freedom rules mean those aged over 55 no longer have to purchase an annuity to access their pension income but can instead enter drawdown or take a cash amount.

So far more than £28bn has been withdrawn from schemes since the introduction of the pension freedom rules in 2015 with each person making an average of six withdrawals.

There has been a 21 per cent increase in the amount of funds being withdrawn from individuals’ pensions in the second quarter of this year, as £2.75bn was withdrawn flexibly, up from £2.27bn in the same period last year.

Alistair McQueen, Head of Savings and Retirement at Aviva, said: “The popular pension freedoms are about to boom like never before.
“Today’s population data suggests the pension freedoms are about to witness a decade like we may never see again.”

Good financial planning coupled with these new pension freedoms can significantly improve the quality of retirement. However, the FCA has recently acknowledged that mistakes were made when they first created the pension freedoms rules.

Keith Richards, Chief Executive of the Personal Finance Society, said the pension freedoms were introduced too quickly, which had allowed scammers to infiltrate the market.

He said measures such as the cold-calling ban, which was introduced this year, should have been in place from the beginning to combat scams.

He said: “The FCA is now making commitments to police the regulatory perimeter, but in the past this area fell between many stools – the police were responsible for investigating fraud, the Treasury and Department for Work and Pensions were in charge of authorising occupational pension funds from a tax and regulatory perspective, and the FCA policed conduct of regulated activity.

“Scammers managed to get enough authorisations to look respectable, without having their activities properly monitored. It took a long time for all the organisations involved to develop a co-ordinated approach.”

Speaking at the Cambridge Economic Crime Symposium on September 4th, Charles Randell, chairman of the Financial Conduct Authority, said policymakers needed to learn lessons from the experience of introducing the new pension rules.

He said: “A very major change of policy like this needs a substantial period of planning and testing, so that all the necessary safeguards against skimming and scamming are integrated before it is launched.”

Mr Randell, noted that pension freedoms were implemented in 2015, relatively soon after they were announced in 2014, but responses to the risk of skimming and scamming are continuing to be developed.

“For example, a ban on cold calling became effective at the beginning of 2019 and the FCA proposes to ban contingent charging for pension transfer advice from next year,” he said.

The Pensions Regulator and the FCA have warned that more than 5m pension savers (42 per cent) were likely to fall for at least one of six tactics used by pension scammers, with the financially savvy just as likely to be fooled.

Last year, 180 people reported to Action Fraud that they had been the victim of a pension scam, losing on average of £82,000 each, the regulators said.

Moving forward, Mr Richards said the regulator must recognise it is difficult for the public to tell the difference between regulated advisers and scammers.

He added: “The authorities need to signpost to what is regulated as well as giving warnings about criminals.”

For financial advisers these scammers have two impacts. On one level we all suffer from the actions of a criminal few. However, those advisers who deliver on their promises and build good relationships with clients benefit enormously from personal referrals. In the short to medium term it is likely that these referrals are going to continue to be the most trusted method of choosing an adviser and maybe that is how it should be.

Author: Toby Nutley
toby@carneliancapital.co.uk
01908 487531 #7

Guardianship

An extremely important part to planning your estate is ensuring it provides for your family after your death.

You may already have a Will in place before you have children and it is important to make revisions once you have started your family.

If a child’s legal parents die or are incapacitated and such arrangements have not been made the court would decide where the child would then live which can be an extremely disruptive process for them.

This can be avoided if a guardian is chosen for the child and included in the Will or there is a grant of guardianship.

There are two types of guardian:

• a guardian of the estate who manages the money or assets held by a child, whether the parents are alive or in the event of their death.
• a guardian of the person who becomes a substitute parent to the child if their parents were do die, become incapacitated or are unable to care for them.

When choosing your child’s guardian you should take time to consider:

• if the person shares your values, goals and parenting philosophy
• the person’s ability to provide financially for the child
• that they are of good character and someone the court would approve of
• they are in good health and are young enough to raise your child through to adulthood

It is important that the person you wish to appoint is advised that these are your wishes and is fully accepting of the responsibility. Once the decision is final, arrangements should be made to include this in your estate planning and your legal representative can advise you on the correct procedure and prepare and file the required documents for you.

Author: Beth Mills
beth@carneliancapital.co.uk
01908 487531 #5