Plan for the worst!

Hope for the best but plan for the worst! Most folk like just enough uncertainty to keep life interesting but not so much as to make them over-anxious. Unfortunately, the current environment puts many people in the second camp.

We are currently facing a ‘flu pandemic and whilst most of us logically know that the chances of it affecting us very badly are relatively slim, we still hate the suspense of waiting our turn at the snuffles. This feeling is exacerbated by the Press, especially when they splash all over the newspapers that yet another apparently healthy individual has (sadly) died from swine ‘flu.

In the wider world the economic and stockmarket uncertainty is also corrosive. Unemployment is rising fast and has a long way to go yet, public sector, corporate and private debt levels are testing and house repossessions and bankruptcies are likely to continue heading northwards. A prime example is the news emanating from Lloyds TSB, which is releasing all its bad employment news incrementally (hoping we won’t notice the big picture). Its recent announcement, which takes target group redundancies above the 8,000 mark, is unlikely to be its last.

And again, the Daily Mail recently reported that senior Tories are now privately admitting that the aspiration to raise the inheritance tax threshold to £1 million and scrap stamp duty for first-time buyers on homes worth up to £250,000 may be delayed because of the recession. One could say that Ken Clarke had already let that particular cat out of the bag in March but it was vehemently denied by the Cameron camp at the time. Personally, I am old enough to know that very few new governments fulfil their manifesto promises made whilst in opposition – and quite understandably so, since they construct their manifestos on grand assumptions which are often far from the subsequently discovered truth (once they actually see the books)!

This leaves investors very poorly served, especially those more elderly and wealthy individuals who should be tackling their Inheritance Tax (IHT) situation sooner rather than later. As one of my oldest and longest-standing friends likes to say: “Hope for the best but plan for the worst.” This is what I would recommend to all those taxpayers who are worrying about whether they should take action to avoid or reduce IHT.

Yes, you should take action. Take all the various steps you need to reduce your potential tax, including getting the 7 year clock ticking now and/or lending financial assets to specialist trusts at currently depressed values. If it subsequently transpires that the planning is not needed then any carefully considered planning can be effectively unwound. Using the right vehicles will incur little extra costs beyond the standard costs associated with establishing any other kind of investment strategy. This warning may sound alarmist but the uncertainty over IHT will be with us for at least another year – until the next General Election – and even then the news is likely to be negative for many years to come. And especially so at a time when there will have to be massive cuts in public services and across the board tax increases to re-balance the nation’s books.

The bigger uncertainty at the moment for most people is the state of the UK economy. Recent stockmarket rises would seem to imply that the recession is all but a thing of the past. And yet many serious pundits are warning of much worse to come. Logic does appear to suggest that the combination of sky-high debt levels across the public, corporate and personal sectors and the delayed effects of the economic slump have not fully worked through the system. With banks still re-building their balance sheets (and likely to continue to do so for some time), lending is not going to improve any time soon. Whilst many individuals and companies have been able to manage their deficits over the last year one can imagine that a continuation of the current credit and earnings drought will eventually take its toll.

My own view is that this cycle will, just as with every previous cycle, pass and we will see recovery. The uncertainty for everyone is when that is likely to happen. With the banks apparently terrified to lend to property buyers, entrepreneurs or even established companies; with southern and eastern Europe all on the verge of bankruptcy; with UK unemployment likely to sail through the 3 million mark leading to more distressed debt and property repossessions; with most stockmarket companies likely to slash dividend rates over the coming months and with the threat of a return of inflation just around the corner, the uncertainty will continue until at least the autumn and probably a great deal longer.

It seems appropriate to end by reminding you again of my friend’s apt catchphrase: “Hope for the best but plan for the worst!” And to reiterate what I’ve already said elsewhere, that this is what I would recommend to all those taxpayers who are worrying about whether they should take action to avoid or reduce IHT. In fact, I would only add one rider to all of the above: “- and do it now!”

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 28th August, 2009 | Tags: Financial Planning |
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Ken Clarke fails to stop Cameron and Osborne committing election suicide

In September 2008 I penned a piece about what I then thought was the likelihood of the Tories following through on their 2007 pledge to increase the personal Nil Rate Band (NRB) for Inheritance Tax (IHT) to £1 million.

The question of increasing the NRB was raised again with Ken Clarke on Sunday 22nd March 2009 by the BBC.  He responded by saying that ‘cutting inheritance tax would not be a high priority for an incoming Tory government’.  He went on to confirm that the Tories were still committed to increasing exemptions on IHT but that the current financial conditions meant that the ambition to increase the band to £1 million was now considered to be an ‘aspiration’.  In a later partial retraction he said ‘we are fully committed to raising the threshold for inheritance tax in the first parliament of a Conservative government.  This measure will appear in the manifesto and I support it.  We also agree that George Osborne cannot write his first budget until we have seen what we have inherited’.

On Monday 23rd March this view was refined again by a statement that confirmed that in future ‘only millionaires would pay Inheritance Tax’.

It is clear from these exchanges that my earlier suspicions that Osborne’s original intention of moving to a £1 million NRB were effectively scuppered by Darling’s inspired move to make the NRB transferable.  By avoiding any specifics over recent days it seems that the Tories are, quite understandably bearing in mind the deterioration in the economy and in government finances, leaving themselves wriggle room.

In the longer term I suspect that the Tories will either, (a) increase the personal NRB to £0.5 million and retain the new transferability rules to give every couple a joint allowance of the promised £1 million, or (b) increase the personal NRB to £1 million and remove transferability. 

However, in the short term I do not think that any major moves are likely because of the state of government finances.  It is more likely that any move towards either of the above scenarios will be made incrementally over a number of years.  The background environment has changed dramatically between 1st October 2007, when Osborne made the ‘commitment’, and today and I do not believe the electorate will accept moves to benefit the ‘wealthy’ during a period when all taxpayers are likely to be hit hard in an attempt to rebuild government finances.  As David Cameron pointed out only last week, the ‘wealthy’ will have to pay their ‘fair share’ during the economic downturn.

With asset values well down, inflation about to turn into deflation and unemployment forecast to hit 3 million in the coming year, the public will feel there is little justification at this moment for taking the wealthy out of any form of taxation!

Changes in Wealth and changes in Public Sentiment – 1st October 2007 to late March 2009
	Oct 2007	Latest 2009	Change
FTSE 100	6,506	3,843	-40%
Average House Price (Nationwide Index)	186,044	147,746	-20%
Inflation (ONS)	4.2%	0.1%	-4.1%
Bank Base Rate (Bank of England)	5.75%	0.5%	-91%
Unemployment levels (ONS)	5.2%	6.5%	+25%
Movement in unemployment since 1997 (ONS)	Lowest	Highest

 

 

Paul Wilcox
Chairman & Technical Director, WAY Group.

Posted on 23rd March, 2009 |
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Humanitarian aid is in our hands

Returning from Australia late in January we avoided travelling for 26 hours non-stop by taking a two day stopover in Dubai.  Having spent a miserable time being monsoon rained upon for days on end in the Whitsunday islands (discovered by James Cook, British navigator on Whit Sunday in 1770 – us Brits are nothing if not logical, albeit somewhat unimaginative) we were determined to have some last minute sun before returning to our cold and snowy shores.  Five o’clock in the morning approaching touchdown at Dubai’s new airport terminal the pilot announced that for the first time in several months it appeared to be raining in Dubai.  I was beginning to take things personally.

We had last been in Dubai just a year ago, en route to another sunspot, as we have tended to do.  It is a great stopover with good hotels, generally reliable weather and a relaxing environment to bridge the gap between 24/7 holiday and the realities of home.  We stayed, as per normal, at the Hilton Jumeirah Beach hotel just along from the ‘sail’ of the famous Al Burj.  Ten years ago this hotel stood in splendid isolation on Jumeirah beach, with unspoilt views in every direction.  Today its ten stories are completely dwarfed by the rows of 40-50 storey beachside apartments which line the new promenade directly across the road from the hotel.  We have watched these apartments being built over recent years and have been fascinated by the working practices employed by the local building companies.

 Allegedly because of the heat they run their building sites 24/7 bussing in hundreds of workers three times a day for each eight hour shift, day and night.  There has been a great deal of controversy about the extremely tough conditions endured by building workers in Dubai, most of whom come from places like Bangladesh or Pakistan.  This year we walked around all the new developments and there is no doubt that progress has slowed a great deal.  There are plenty of ‘immigrant’ workers but their numbers are vastly reduced from previous years.  The global credit famine is hitting Dubai hard.

 With a tiny Emirati population and a large but quickly shrinking ex-pat community one wonders who is going to buy the thousands of properties being built.  Most residents of Dubai (between 80% and 90% are ‘visitors’ working on short term visas) are male and working to support families elsewhere.  With the economy going through a tough time many are losing their jobs and leaving the country.  At the same time property investors around the world are pulling in their horns.  This leaves Dubai property companies selling off luxury villas and apartments at massive discounts.  Maybe more important, however, is the fate of the erstwhile imported labour who, whilst earning a pittance by western standards, relied on their sparse income to support their families in some of the poorest parts of the world.

 This reminds me of some research trips I took several years ago which later led to many heated dinner table debates about capitalism and exploitation of labour.  This has become a major social issue in the intervening years.  I visited a huge clothing factory in Bangkok in the 1990s which made women’s fashion clothes for companies like Top Shop and Marks and Spencer.  I remember visiting the quality control department run by ex-pats on behalf of M&S.  This factory employed young teenaged women who, allegedly, supported their families (who mainly lived in pretty awful conditions on the banks of the river).  They earned very little by western standards but were all nattily dressed in jeans and t-shirts or blouses, wore watches and jewellery and, bearing in mind the daily challenges of their lives, were of a surprisingly cheerful disposition.  Whilst there were no obvious abuses of workers in this particular workplace, the whole area of exploitation of poorly-paid workers in third world countries has become an ongoing scandal in contemporary life.  Even in the buoyant economic times pre-2007 the moral tensions between possible abuses on the one hand and offering people a means of climbing out of destitution on the other, were difficult to unravel.  How much more difficult is it now?

 The Financial Times recently reported (2nd February 2009) ‘more than 20 million rural migrant workers in China have lost their jobs and returned to their home villages or towns as a result of the global economic crisis, government figures revealed on Monday.  The job losses were a direct result of the global economic crisis and its impact on export-oriented manufacturers, said Chen Xiwen, director of the Office of Central Rural Work Leading Group.  He warned that the flood of unemployed migrants would pose challenges to social stability in the countryside’.

 It is a similar story across many of the poorer countries of the world.  Most of these ‘redundant’ workers have no state safety net, no social insurance, basically no hope.  And this is the awful thing about the current economic ‘crisis’.  We in the west are suffering from fear, and in some cases reduced incomes or even redundancy, but our very existence is not being threatened by this recession.  Around the world many thousands of people are facing starvation simply because western consumers have put a brake on their consumption.  Remember that something like 70% of world economic output relates to consumer spending.  No wonder economies around the world are suddenly in a mess.  We do not have to reduce our spending very much for the economy to come to a virtual halt and that is precisely what has happened. 

 As I wrote previously, the solution to this dilemma is in our hands.  Strangely there has still been no strong and charismatic leadership shown in this crisis.  I expected Barack Obama to galvanise the American people in his inauguration speech.  I expected Gordon Brown to attempt to hint at it in his speech to Congress when he recently visited Washington.  I have expected the right exhortations to come from the lips of some world leader somewhere in recent months!  But no.  The public will respond to an appropriate impassioned plea to take action to stamp on this recession.  It does not need VAT reductions.  It does not need tax rebates.  It does not need interest rate reductions (which takes spending power away from the grey economy where it is easiest spent).  It does not need public spending.  What it needs is a charismatic leader to explain to the public that they need to get back to leading normal fearless lives, where they resume their previous levels of sensible rational spending.  This will save the world.

 What the world needs now is a resumption of ‘business as usual’.  Otherwise the price to be paid by millions living in the world’s poorest nations does not bear thinking about.  Maybe we, as influencial people in our communities, should be spreading the word because it seems that no-one else is going to.

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 20th March, 2009 |
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Once in a lifetime IHT planning opportunity

Anecdotal evidence seems to indicate that few advisers are working on Inheritance Tax mitigation at the present time and yet in reality the credit crunch has generated the most ideal environment for such planning for many years.  Whilst it is true that the transferable Nil Rate Band has taken a number of more modestly wealthy individuals out of the IHT trap, the number of taxpayers likely to pay this tax still appears to be substantial.  Of course, advisers are saying that their wealthy clients are more taken up with repairing their personal balance sheets (after the hits they have taken from the credit crunch and stock market rout) than they are with mitigating tax.  This is, however, a foolish approach since the credit crunch and its impact is temporary whilst the prospect of gifting one’s hard earned wealth to the Government is permanent.

I have been looking at house prices in London to get an idea of the temporary impact of the wealth destructive effects of the mortgage famine (which I believe is the real culprit in house price falls).  Looking at terraced houses, which represent the modest living accommodation of average Londoners, it seems that those living in suburbs like Camden, Fulham and Islington (even after recent substantial falls in values) still have properties worth in excess of a couple’s Nil Rate Band.  Meanwhile a couple living in Wandsworth have seen their terraced house fall from £620,000 down to £500,000.

 The other disincentive when considering IHT planning has been the dramatic falls in equity values.  During 2008 a massive 31% was wiped off the (FTSE 100) value of shares, a reversal not seen in any other year since the FTSE 100 was launched in 1984.

 These falls in personal asset values beg the question as to whether it is correct that taxpayers have become distracted from considering their potential IHT positions.  In my submission, whilst I understand the current concerns about rebuilding assets, there are very many reasons why taxpayers should be focusing on IHT mitigation at this very moment.  The main three, which I will cover individually are: (1) the seven year clock necessary to remove assets from one’s estate should be started as soon as possible; (2) the depressed value of personal assets at this time offers a ‘once in a lifetime’ opportunity to supercharge any such planning, and; (3) the availability of highly flexible schemes based on both unit trust portfolios and bonds means there is no reason to not put IHT mitigation in place as an additional benefit of normal portfolio planning.

The Seven Year Clock
Recent research (from WAY Group) indicates that taxpayers adopting IHT mitigation are doing so much later than they perhaps should to get best value from the seven year period it takes for asset transfers to fall out of one’s estate.  Men typically start planning at age 69 and women at age 72.  That leaves the average person with only one complete seven year period between starting IHT planning and when they are likely to die.  So the earlier one starts IHT planning the better to make sure one survives the seven year run-off period or even to enjoy more than one set of gifts (more than one seven year period).

Once in a lifetime opportunity
There is little doubt that today is a great time to be doing one’s IHT planning.  Why?  Because:

•         Proportionately one can remove far more from one’s estate today than a year ago, and probably in a year’s time, because of depressed values. Transfer now whilst prices are cheap.
•        There will inevitably be a recovery and assets will substantially increase in value.  Whilst nobody really believes the Halifax statistics for house price rises in January it does give some indication that there will soon be a bottom and then a recovery.  This is linked far more to the availability of mortgages (which disappeared for several months in 2008 and under Government pressure are now reappearing) than to sentiment.
•        We have seen the early green shoots of stockmarket recovery since the lows of last year and no-one should doubt the potential for a worthwhile recovery this year.
•        By moving assets into trust now, the resulting change in beneficial ownership will trigger a Capital Gains Tax (CGT) point, BUT at current depressed levels very few people will have to pay any CGT.
•         Any recovery in values, once assets are transferred, will conveniently occur outside the donor’s estate thereby saving substantial IHT on that extra value (IHT savings at 40% far outweigh any future CGT at only 18% on gains above the allowance).

With Government finances in a mess there are unlikely to be further cuts in IHT for the foreseeable future, regardless of which political party is in Government.  So there is an extremely strong case for those potentially liable to IHT to get the seven year clock ticking.

 No reason not to plan
Until a few years ago IHT planning involved putting on a financial straitjacket whereby putting assets beyond the reach of the tax man normally involved putting them beyond one’s own reach (other than possibly a fixed future ‘income’).  In addition, most traditional IHT arrangements were based on life assurance bonds and their often inconvenient attendant Income Tax status. 

 Those restrictive days have long gone and the IHT mitigation market has moved on very much in line with other contemporary developments in the investment management arena.  It is now possible to engage highly flexible trust arrangements in which trustees have extensive flexibility in passing benefits to the donor and/or beneficiaries as dictated by circumstances rather than simply by prescription.  In addition these arrangements can now contain the kind of managed portfolios investors would have held, in any case, had they not been planning for IHT.  It is now even possible for IHT-shielded portfolios to be managed on the most contemporary of investment platforms.

 The trust flexibility and investment options available today mean that the only argument for not placing an IHT mitigation trust around a client’s portfolio is the marginal extra cost of doing so which, even with trustee fees, normally works out at less than 1% per annum.

Advisers would be well advised to look afresh at contemporary IHT planning which is no longer a ‘magnum opus’ and simply represents a best practice ‘add-on’ for any portfolios managed on behalf of wealthy clients.

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 13th February, 2009 |
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Far too clever, cobber

We had left for Australia early on Boxing Day and in the rush had forgotten to buy any adaptors to convert from UK to Australian electrical sockets.  So our first stop on the way from Brisbane airport to our relatives’ house was at an electrical store to buy the necessary.  I was slightly taken aback at the cash desk when the young man asked me what on earth had happened in the UK to lead to the failure of such a great name as Woolworths.

 Little did I know that the electrical store I visited was owned by Woolworths and run by passionately loyal employees of Woolworths (Australia).  The following day we were taken to a large and very impressive supermarket – Woolworths – looking amazingly like one of our best Tesco stores in the UK.  Whilst Woolies in the UK has gone to the wall, the giant and very well-managed Australian version is actually the 22nd biggest retailer in the world, according to recent global research by accountants Deloitte.  The top three are Wal-Mart in the US, Carrefour in France and Tesco in the UK, but Woolies Australia, at almost half the size of Tesco in terms of turnover, is a real star bearing in mind the very much smaller market in which it operates.

I later learned that Woolworths, Australia, a major supermarket group, whilst owning a number of large speciality chains (such as electrical and wine stores) is also a leading brand in petrol stations, hotels and casinos.  What a very different story to their UK counterparts.  Unfortunately it all comes down to vision and quality of management.  Tesco had the vision 30 years ago to raise its game and play to the future whereas Woolworths UK remained in its post-war time warp.

 A few days later we were doing the obligatory river cruise through the beautiful and modern city of Brisbane when our attention was drawn to a massive and extremely artistic neon sign on the main wall of the Brisbane Gallery of Modern Art about half a mile away.  It gave out one huge message, the title of their current multi-media exhibition – OPTIMISM. 

 These sentiments were prevalent everywhere we went around Australia.  On a subsequent trip up the coast to an ocean resort at Noosa the local newspaper was full of opinions about the threat of recession.  Tex Pipke, head of the Cooroy Chamber of Commerce, suggested that “this community is opposed to the idea of recession in Australia, to the point that we might not participate.”  Speaking about local developments in trade and tourism over recent years he went on to say “Why would we be depressed?  We have a lot to celebrate, so let’s not go out there and participate in this recession.”

 Whilst I have been away on this antipodean trip I have had plenty of time to read the endless analysis both by competent and less competent journalists, business people, financiers, bankers and intellectuals, attempting to explain how the crazy explosion of inappropriate credit over the last decade led to the inevitable credit crunch which in turn is leading to a massive global recession.  All of this intellectualisation is fine but it fails to address the missing ingredient – what to do now.

 We have had massive sell-offs before, often following major financial dislocations in the market place.  These have involved various different sectoral difficulties over the years, the most recent being the bursting of the ‘tech bubble’ in 1999.  Each time we have managed to overcome the challenges and move forwards.  Unfortunately this time the credit crunch symptoms (in essence a sectoral difficulty) were immediately identified with the 1930’s depression and as a result we have ‘apparently’ moved directly from healthy economic world growth to a self-induced and completely unnecessary recession. 

Obviously the tightening (and often unavailability) of credit has had an impact on personal and corporate capital spending but, as an example, I needed to upgrade my own car in August 2008 and had no difficulty whatsoever in getting extremely inexpensive terms from a finance company owned by one of the big four banks (as was).  So why has the sale of motor cars fallen so dramatically over the last year?  Not just in the UK or the United States but virtually everywhere in the world (car production in France was down 8.1 per cent in November after October’s 22 per cent plunge according to Insee, France’s national statistics agency).  The knock-on effects of a slowdown in the car industry have affected many other connected industries.

 It appears to me that the whole world has gone mad.  Yes unemployment has risen but spending reductions have not been limited to those unfortunate to be out of work, everyone seems to have completely stopped spending.  As a result manufacturers have stopped ordering raw materials and retailers have stopped ordering finished goods.  Most capital spending has stopped or is stopping and everyone is cutting revenue spending.  Trade is falling off a cliff. 

 The strange thing is we are all accustomed to a certain standard of living.  With interest rates now on the floor, oil prices at almost a quarter of what they were early in 2008 and various other prices becoming competitive (Australia is now over the drought of recent years and is heading for a bumper harvest) the panic will surely ease.  Then we will be spending again, probably as early as later in 2009.  Many UK consumers have seen their disposable income rise by between £5,000 and £15,000 per annum net over the last year.  So, suddenly consumption will be up – relative to now – but everyone in business will be completely de-stocked!  There will then need to be a dramatic resumption of manufacturing/production.  So there will be a resumption of the classic ‘go’ part of the age-old ‘stop/go’ cycle and off we will go again!

 I believe Gordon Brown, Barack Obama, the Chinese Government and all other sensible thinking people wishing to prime-start their economies are absolutely correct, BUT without the consumer, who accounts for a huge proportion of overall global economic activity, normalising consumption, these other measures will take forever to work.  Intellectual discussion and actions by central governments are all well and good but what the world needs now is a return to normality. 

 The last time there was a widespread call for normality from the public was immediately after 9/11 when New York mayor, Guiliani, went public with a plea for New Yorkers to ‘carry on as normal’ (go shopping, go to the theatre, go to the restaurants).  His motive was more by way of a message to Osama bin Laden that the West would not be compromised, but his call was answered by the people.

 The current situation is not related to terrorism, but it is nevertheless extremely serious.  Whilst we do not want anybody to spend above their means nor to borrow money they can ill afford to borrow, it is important that we normalise our consumption patterns RIGHT NOW, if we are to avoid a short sharp and damaging recession.  If you are due to trade up your car, if you are due to take a holiday, if you are due to spend money on an habitual basis then do so, now.  If we all do this then we can avoid this imminent recession.

 So, cobber, stop intellectualising about the credit crunch and the subsequent chaos and get back to living your life as per normal – just like the Australians want to.  That way we can all survive this man-made disaster that the Press are constantly talking us into.  As Nike says ‘just do it’ and I suggest you convince all your friends and family to ‘do it’ too.

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 20th January, 2009 |
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Sell, sell! Buy, buy!

We all know that markets and share prices are governed by fear and greed whereby bull markets are characterised by greed and bear markets by fear.  We also know that markets overshoot on both the upside and the downside – often within a short space of time.  Surely this is exactly what we are seeing right now.  If the banks were overvalued just a few months ago, surely they are undervalued now, similarly with builders and miners.  Most of us remain in a state of hung over trauma having seen a buoyant market and economy fall off a cliff in very short order.  Of course the falls have not been consistent across all sectors, as implied above, and the trick now is to determine what sectors should be backed if, and when, we can anticipate the pendulum swinging back into more positive mode.

 Not that the investing public is feeling any more positive yet.  Presently all news seems to be bad news, even when it is good!  Inflation falling would normally be considered good news but currently it is a harbinger of the dreaded deflation.  Interest rates falling would normally be considered good news but because up to a half of mortgage payers will not receive the full benefit then it is considered bad news.  Falling Sterling making our exports more competitive would normally be considered good news (look what it did to stimulate our economy in the early nineties) but because our imports will cost more and overseas investors will have less confidence in the UK then it is considered bad news.

 All this ‘bad’ news makes our market fall.  When interest rates fall, when inflation falls and Sterling becomes more competitive the market falls.  When Gordon Brown announces there will be substantial fiscal measures to stimulate the economy the market falls.

 This does not make any sense.  The fact that RBS spent more acquiring ABN Amro recently than the total current market capitalisation of Barclays, Lloyds TSB, HBOS, Marks & Spencer, J Sainsbury and WM Morrison defies logic.  Sure they may have paid too much but not so much that realistically they could have bought all those other major UK companies instead!  Many companies today are ‘dirt’ cheap. 

 The fact that many shares can be purchased at less than last year’s earnings defies logic.  The fact that our own natural everyday consumption habits will underpin the financial future of most major UK companies means that there are some terrific bargains out there.

 In managing a broadly based portfolio, managers will normally have an eye to combining undervalued assets (to achieve competitive performance) with a wide diversification (to harness and restrict volatility).  The current environment makes this task particularly important and exciting over the months ahead.  WAY Group is unusual in having its portfolio funds managed by a selection of external managers.  Not surprisingly its three main, but entirely independent, managers agree on the prospects for the next market phase.

 John Husselbee at North Investments, manager of the WAY MA Cautious portfolio which has recently been moving from cash back into the markets warns “There is no doubt that the past few weeks have given investors a white-knuckle ride that would test anybody’s faith in financial markets. There may be some who want to get off now, some who are concerned but will stick it out and even those fully prepared to take more. What you need to avoid being is the investor who gets off near the bottom, taking a large loss and giving up any potential for recovery and future growth.”

 Meanwhile Jason Britton of T. Bailey, running the more adventurous WAY MA Growth portfolio, is already working out a broad strategy going forwards.  He agrees “Returns may be volatile but one of the most important factors in relation to equity investment is when one invests and when one sells, and if you are investing for the long term then equities appear to be offering good value at the current time.  A lot of bad news has been priced in from recession, through to the financial crisis and the de-leveraging of hedge funds.  There may be further to go as the consequences of the financial crisis filter out and create ripples in even more unexpected places, or as the recession proves deeper than currently envisaged, but there is a real danger of looking back in a few years time and kicking oneself for not taking advantage of recent falls, even if markets may yet be cheaper next month.”

 On strategy Britton says “Currently we are weighting the equity portion of the WAY MA Growth Portfolio to the US and Japan.  The US was the first into a slowdown and is likely to emerge first too.  Outside of financials, the earnings reporting season is generally providing good news and whilst the outlook may be deteriorating corporates are coming from a position of strong cash flow and low-ish leverage.  But investing in the US also comes with a safety net for UK investors, namely a rapidly strengthening Dollar.  Whilst the extreme moves of recent months may not continue, we anticipate there being a bit further to run here.   Japan is also providing a mix of buy-signals none of which in isolation would be sufficient to get excited about, given its propensity to disappoint, but the weight of data suggests that Japan may move more quickly than other markets when things settle down globally.”

 Meanwhile Paul Kim of IMS Fundquest, who manages the WAY Global Portfolio range, reminds us of the benefits of the managed portfolio style adopted within WAY,
“I believe funds of funds provide a good spread for investors, with a variety of expert managers ‘at the coal face’ picking stocks that should weather the storm and emerge stronger. This diversification avoids having too much specific risk, in any one stock or sector. However, many very well-managed companies have been tarred with the same brush and have seen their share prices knocked disproportionately and now represent excellent long term value.  We seek to back those managers best likely to identify and run with undervalued companies and sectors.”

 The message is pretty clear.  There may be more downside yet to come in the market but attempting to finesse timing to hit any such further fall is far too dangerous.  The general market represents excellent value right now but for the talented manager there are some real gems out there where performance of hundreds of percent are on the cards over the next couple of years.  The clear message then is to be committed to the market right now and to get in while you can at these bargain basement prices.  Not only will we all make money (including recouping some of our recent losses) but we can bring much-needed confidence back into the market and into the economy – you could say it is our duty!

In any case and in spite of rumours to the contrary, the property market, which was allegedly the initial cause of this fall-out, is actually not dead.  Recent figures from the National Association of Estate Agents indicate that sales per agent are up from 5 per month in August to 6 per month in September, climbing again in October to 7 sales per agent.  Unless one is mistaken that seems to represent an increase of 40% from the bottom.  Is this good or bad news?

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 20th November, 2008 |
Comments: Have Your Say

Cash and the fourth dimension

Until recently the consensus view in the retail press and amongst many of the investing public was that cash, and only cash, constituted low risk investment.  However, following the failure of the Icelandic banks and fears about the solvency of banks generally, both here and virtually everywhere else worldwide, such an assumption suddenly seems rather shaky.

 We recently launched a cautious equity-based fund which was held largely in cash until mid-October.  Against a background of tumbling equity markets imagine our surprise that all enquiries by prospective investors and their advisers about the security of the fund focused purely on the cash holdings!  Investors seem well acquainted with the perceived risks within the equity markets (the memory of 2000-2003 is fresh in their minds) but suddenly are worried about the security of their cash holdings.  This brings me on to consider risk in the wider context where I see two distinctly different categories of risk – absolute risk and price risk. 

 Absolute risk is related to losing one’s stake in its entirety – as one generally does on the gaming tables.  In investment terms this normally only happens when the entity in which you have invested, primarily as a shareholder or sometimes as a depositor (think Icelandic banks), goes bust.  It can also happen when a company is nationalised, such as Northern Rock, when shareholders also lose everything. 

 Price risk, on the other hand, is where an investor buys an asset for which the price is determined by the market forces of supply and demand.  If you buy RBS shares today, will the price rise or fall between the point of investment and any subsequent sale?  Having fallen some 90% or so from its peak and now that its future has been underwritten, RBS should have zero absolute risk and, probably, a very low price risk (the FT website was recently quoting a prospective running dividend yield of 33% – we know this wont happen but it puts the current share price into context compared with recent profit and dividend levels).

 There is little to say about absolute risk other than to emphasise that it is sensible for investors to do adequate due diligence before investing in any company that is vulnerable to currently deteriorating economic conditions.  There is plenty to say about price risk and it is here that the fourth dimension of time, and of course timing, comes into play.

 Both Warren Buffett and Bill Mott have gone on record recently to say that all the risk is currently in cash.  This is not because of prospective bank insolvencies but because interest rates are going to fall to very low levels so that real returns from holding cash are likely to be negative, even if one allows interest to roll-up.  On the other hand equity investment at this historical point in the market is likely to offer both decent yields and substantial capital growth, so long as one follows the basic rules of investment – of which number one is diversification and number two is to invest for the medium to long term (the fourth dimension).

I believe that equity value in the markets is greater than at any previous point in my lifetime and likely to be greater than at any point in the rest of my lifetime.  Of course prices could go lower (although I doubt they will go much lower) but in years to come this period will be looked back on as a once in a lifetime opportunity to make big money from equities – especially in the sectors which have bombed so badly in recent days and weeks.  Personally I am borrowing what I can to buy banks, builders and miners right now, many of which are down 90% or more from their recent peaks.  Even a recovery to only 25% of previous levels equates to a performance of several hundred percent from this point!

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 28th October, 2008 |
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HMRC plays the ageism card on IHT planning

The value of a gift for Inheritance Tax purposes is calculated not by reference to the value of what you have given away but by reference to the diminution of your estate as a result of making the gift.  This subtlety avoids evasion by making small gifts which dramatically reduce the value of one’s estate – for instance by gifting away a minor 5% shareholding which removes voting control from the donor!

 In the case of a traditional discounted gift trust the value of the gift into trust is discounted by the value of benefits retained by the donor.  So if a taxpayer gives away a £200,000 investment (normally an investment bond but in some cases unit trusts) but ‘carves out’ and retains an annual reversion of 5% or £10,000 per annum, then the value of the gift is £200,000 less the value of the retained ‘income’ rights.  The value of those rights at the point of making the gift obviously depends on how long the donor is likely to live and on assumptions about interest and inflation rates.  If the donor is likely to live 20 years (and will therefore likely receive a return of £200,000 over that period) then the discount will be very large.  The older the donor is at the time of making the gift the lower the discount will be.

 This process and valuation model is totally logical and actually reflects the accepted means of calculating the discount on such mitigation schemes.  In spite of this generally practical approach to discount valuation the technical definition is somewhat different and is enshrined in Section 160 of the Inheritance Act 1984, which puts an ‘open market value’ on any rights carved out and retained by a donor in such schemes.  Since an open market value is largely a theoretical concept – donors never actually wish to sell their ‘income’ rights – HMRC are happy to rely on the actuarial model described above.  So happy are they that they have spelt out, in guidance notes, precisely how the calculations should be made and what mortality tables should be used.

 The problem with the elderly has arisen over the last 5 years or so since when the HMRC has imposed its own interpretation of what constitutes an open market value.  They have been claiming that no discount is applicable to elderly donors because no potential open market purchaser would be able to ‘insure’ against the failure or potential loss resulting from their purchase, by taking life cover on the donor’s life (due to lack of demand there are very few opportunities to insure the lives of those aged 90 and over).  They suggest that an inability to insure means that the rights would have a nil open market value – they would be unsaleable.

 Last year a case went before the Special Commissioner because HMRC had once again disallowed an actuarial discount to a lady of 90 who had invested in just such a scheme and died several months later.  The challenge to HMRC had been sponsored by AXA Isle of Man whose scheme was involved.  There was a collective, albeit premature, sigh of relief in February following publication of a ruling by the Special Commissioner granting a compromise discount to the donor.

 On 7th February 2008 Special Commissioner, Howard Nowlan, ruled that the derisory £250 nominal discount offered by HMRC to an elderly DGT client was unreasonable. The case, the evidence presented and the ruling were all extremely important for those of us working within Inheritance Tax mitigation. 

For me the crunch here is that the legislation talks of ‘open market value’ but makes no reference to insurability.  The HMRC have been relying on standard practice of specialists like Foster & Cranfield who deal with the valuation and sale of second hand annuities and insurance policies.  Commissioner Nowlan, I am pleased to say, approached the whole issue from a more common sense perspective and noted that regardless of her potential insurability, or otherwise, there would be plenty of theoretical investors who would be prepared to take a ‘punt’ on her life at the right price – including himself!  To suggest that the lady’s retained lifetime ‘income’ stream could be valued at the final and derisory HMRC offer of £250 when that ‘income’ stream yielded a net return of £304.16 per month was nonsense.  She would only have to live for a month for the purchaser to be left in profit and whilst she was certainly of impaired health she could reasonably have been expected to live at least one month!  He did comment that a 90 year old in normal health would be expected to have a substantial life expectancy and a much larger discount would therefore be appropriate.

 It has now been reported that HMRC is still not content to accept the Special Commissioner’s compromise discount value and plans to appeal.  This is disappointing but not necessarily a surprise.  Mr Nowlan actually came up with a somewhat ‘Heath Robinson’ approach to valuing the discount which involved taking two thirds of the calculated actuarial discount and then deducting likely expenses of £1,000!  I think all of us would have preferred a straightforward acceptance of the practical and traditional approach used for those under the age of 90 and which was generally accepted until a few years ago.  Anything else amounts to ageism in its meanest form.  The graph shows a typical level of discount applicable at different ages and indicates that whilst discounts will gradually reduce with age there is no justification whatsoever for them to ‘fall off a cliff’ to nil at age 90 just because HMRC wish to arbitrarily hit those least able to defend themselves.  How can income or withdrawal rights be very valuable one week before attaining the age of 90 and have no value one week later!

 We await the appeal process with interest and hope that reason will prevail.

 In the meantime it was usefully stated in the judgement from Mr Nowlan that “it was accepted by HMRC that the 5% annual withdrawals under the policy, these being the sole entitlement of Mrs. Bower under the Trust, would be tax free and would occasion no liability for higher rate tax as “chargeable events” under the Income Tax provisions relating to insurance policies. It was also accepted that as Mrs. Bower’s rights were clearly defined, there would be no question of her being treated as having made a gift with reservation of benefit for Inheritance Tax purposes such that the whole gift would be disregarded. It was also accepted that she was not to be treated as having a life interest in the whole of the settlement and treated as owning all the settled property for Inheritance Tax purposes”.  Pre-owned asset tax would therefore also not apply. 

 In essence we have been delivered a watertight judgement about the general efficacy of Discounted Gift Schemes even if we temporarily remain in disputed territory for older clients entering such schemes.

Mark Benson,
Technical Manager, WAY Group.

Posted on 20th April, 2008 |
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Multi-manager a.k.a. unitised portfolio funds

The concept of collective investment has been around for almost a century.  Unit trust companies like M&G and Save & Prosper were pooling investor funds and investing with the benefits of economies of scale from the 1930s onwards.  The principle of collecting together investors’ moneys and then appointing a specialist stockpicker to run a large and effective fund of invested shares became very popular with the more sophisticated investing public.  Instead of having an individual portfolio which needed regular attention, large amounts of administration, including the completion of annual tax returns, and the potential for regular tax liabilities every time profits were taken, investors could suddenly buy and enjoy owning a collective fund.  The benefits were not limited simply to convenience or to putting off any tax liabilities.  The primary benefits were the ability to achieve much greater diversification than would be possible with one’s own limited portfolio and the opportunity to share in the rewards of employing a top class manager and his or her 24/7 team rather than simply your tired local stockbroker.

 In those early days investment tended to be limited to the UK market where many international companies were, in any case, listed.  As exchange controls disappeared (as late as 1979 in the UK when Margaret Thatcher opened up the markets) it then became more conventional to have some exposure to overseas companies within your mainly-UK portfolio.  It was in the ensuing decade, the 1980s, when overseas unit trusts really took off.  Specialist funds based on various markets around the world, both large and small, managed by specialist managers who were often based in those geographical areas, flourished during this time.  I recall funds investing specifically in Hong Kong, or Singapore and Malaysia becoming very popular.  During this phase your local friendly stockbroker would have progressed to setting up client portfolios, mainly comprising a range of UK blue chip shares, supplemented by two or three holdings in specialist overseas unit trusts.

 In my own case as a Licensed Dealer in Securities, back in the dim and distant early eighties, I became manager of a range of third party insurance funds.  In my view funds like these were in the vanguard of the Multi-Manager movement.  Regulation then was not even a twinkle in the Government’s eye and yet most of us were highly professional both in our motives for establishing such funds and in the way they were managed.  It was an opportunity to set up a pooled fund of investors’ money and then to invest and manage it across the world, utilising the combined skills of all the top specialist managers and funds available.  Many of those early funds (subsequently dubbed ‘broker bond funds’) were pretty effective for their unitholders.  In those early days the life companies tended to be scrupulous in their vetting of the competencies of anyone wishing to set themselves up as managers of such funds. Generally anyone appointed was extremely talented and professional.

 Unfortunately the success of such funds was their undoing.  They had generally turned in competitive performances during those early years and were attracting increasing amounts of money.  Not only that they gave advisers the opportunity to collect their clients’ assets into a more easily managed format – one which offered not only a greater sense of corporate ownership but a regular management income deducted at source and paid over by the life company.  Soon a number of commercially successful advisers, but with far less adequate skills and experience, were set up with these broker bond funds.  To compensate for their lack of skill certain insurance companies invented ways for such managers to ‘milk’ the system by indulging in historically priced switching – betting on certainties.  Of course any such benefits were always at the expense of the other unitholders in those underlying funds who suffered the cost of such historic dealing.  By this time the new Financial Services Act was in force and it was not long before broker bond funds were under the microscope.

 As one door closes another one generally opens.  Whilst the broker bond saga was brewing the more purist investment industry, comprising the unit trust companies, was developing funds which were not invested in shares but instead across a range of other specialist unit trusts – the fund of funds unit trust was born.  Initially such funds were only permitted to buy underlying funds on a charge-free basis in an attempt to avoid double-charging.  Fortunately it was not long before rule changes were introduced into the administration of such trusts whereby fund of funds unit trusts were permitted to buy underlying funds at ‘best’ rather than at cost.  This was October 1991.  Being the unit trust industry this development was seen as offering a more comprehensive means of accessing specialised markets rather than as a potential panacea for portfolio investors.

 For us portfolio-style managers, however, it offered an even more effective means of delivering collective portfolio management than was available from the old broker bond funds.  The costs were lower and the potential tax savings were even greater.  Firms like Old Mutual and what subsequently became Capita, started offering their unit trust administration structures to third parties who wished to manage their various clients portfolios on a more efficient, contemporary and effective basis.  Firms like WAY have come in later offering even more specialised services whereby third party managers can access sophisticated financial planning structures underpinned with their own funds and/or fund management.

 Recent bear markets and the associated volatility within funds and markets have continued to highlight the benefits of Multi-Manager style investment in the hands of competent and independent managers.  More recent changes in fund rules permitting greater mixing of asset classes has improved the scene even more, allowing the professional Multi-Manager to utilise all the important funds, managers, assets, asset classes and financial instruments to generate competitive returns with low volatility.  We must not allow this success to be the undoing of the new breed of third party MultiManagers just as we did with broker bond funds.

 In reality TCF dictates that we all manage our clients’ assets in the most effective and fair manner possible.  So long as MultiManager funds are established with very clear investment mandates and are managed appropriately by fully-qualified and top-class managers they will go from strength to strength.  Long live the MultiManager Fund!

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Note: WAY Fund Managers has recently launched a new Multi-Manager fund, the WAY MA Growth Portfolio, managed by T. Bailey Asset Management.  WAY Fund Managers also acts as host ACD to several third party unit trusts under the Elite banner.

Posted on 1st April, 2008 |
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Pernicious tax hits surplus pension funds

For many years there was a persistent clamour from the financial community and from aging pensioners for the Government to change the rule that made the purchase of an annuity compulsory for 75 year olds with non-vested pension funds.  This was because pensioners wished to keep their funds intact for their beneficiaries to inherit when they finally departed this mortal coil rather than pay out the accumulated fund in exchange for what was often a surplus and highly-taxed income.  Similar funds for those departing before age 75 had been available for payment to beneficiaries free of Inheritance Tax (IHT) and with increasing life expectancies it was becoming obvious that compulsory annuities at this increasingly young age were a problem.

 Gordon Brown came up with a great solution – the Alternatively Secured Pension or ASP.  This was launched in April 2006 having been mooted as long ago as 2003.  It allegedly came about as a result of the Plymouth Brethren objecting to being forced into ‘gambling’ on life expectation – which is how they view annuities.  Gordon Brown took due notice of their concerns and introduced ASPs aimed at those with principled religious objections to annuities. 

 As he has subsequently pointed out many times, they were never intended as a means for wealthy people to pass on tax-advantaged savings to dependents.  In other words, although residual pension funds left by pensioners dying before age 75 can be passed to beneficiaries, he is determined that those living beyond that arbitrary age should be committed to either taking an annuity or losing their funds to the tax man!  This is why he launched the concept in April 2006 and effectively knocked it on the head again in December 2006 by imposing a tax and penalty charge of up to 82% on residual funds!

 So in effect we are back to taking our pensions by some means or another before age 75 and finding an alternative route to diverting them to our families in the most tax-effective manner possible.  This is particularly the case for all those post-war baby boomers who have acquired non-pension assets well in excess of their likely lifetime needs in addition to healthy and ‘surplus’ pension funds.

Is there an alternative means of dealing with a surplus pension fund of £1 million which can both:
           a)      Allow beneficiaries to receive more than the derisory 18% on offer if it goes into ASP?
           b)      Avoid the compulsory income accumulating in the individual’s estate and thus inflating their IHT liabilities?

 The simple answer is yes, and how some!  Although the saver does not need the money the sensible approach is to take the maximum tax free lump sum (of 25%) early on in the process.  On £1 million this will equate to £250,000 which can conveniently be gifted into a flexible IHT mitigation trust to remove it from the tax man’s reach whilst retaining flexible planned access.  So long as the saver/settlor survives seven years this will become IHT free ready to be passed to beneficiaries whenever it appears appropriate (this option is available under a flexible trust during the life of the settlor). 

 Maximum pension/drawdown should then be taken.  This may suffer 40% Income Tax but since (a) it derives from savings which probably enjoyed this level of relief when contributions were made and (b) it has grown in a tax-free environment within the exempt fund, such a tax can be considered neutral.  The ‘pensioner’ will then be in possession of regular slugs of net income.  Of course this is taxed income which is surplus to living requirements and is regular.  Hey presto an obvious candidate for ‘normal expenditure’ gifting.

 Now I am not going to suggest that the recipient gifts this money to his or her beneficiaries completely and immediately free of IHT from that point until death – although I could.  It would seem quite tax efficient.  No I am going to suggest that he or she gifts it, on an immediately exempt basis, into another flexible IHT mitigation trust so  that it too can be available to the pensioner should it ever be necessary.  However, just as with the lump sum arrangement the trustees can also make monies available to beneficiaries during the settlor’s lifetime should this be necessary.

 To put this effect into context consider the retiree who has an untouched pension fund of £1 million and dies one month before his 75th birthday.  His beneficiaries can inherit the whole fund entirely free of IHT.  Contrast this with the same person who lives the extra month and is all set to take his pension under the ASP rules.  He dies within the first month and because he has already gone into ASP his beneficiaries suffer the full 82% tax and penalties and receive only £180,000 (rather than the £1 million they previously would have received).  Can this be right?  The arbitrary nature of the 75 year old deadline is crass to say the least.  This immediately begs the question as to whether the retiree should have taken the tax free lump sum and entered drawdown just before his birthday.  This is a great idea except that a male aged 75 has a life expectation of something like 9 years which is perilously close to the 7 years needed to move the tax free cash outside his estate and escape IHT.  It will also leave 75% of his fund at the mercy of the 82% tax.  Were he to do this and then die his estate would potentially suffer 40% on the tax free cash (40% of say £250,000 leaving £150,000) and 82% on the residual £750,000 fund (leaving 18% of £750,000 which is £135,000).  This would still be worthwhile compared with not taking the tax free cash (beneficiaries would potentially receive £285,000 rather than £180,000) but we can do even better.

 The trick is to take the tax free cash and enter drawdown early enough to reduce the residual fund.  Every monthly pension payment which is taken and transferred into a ‘normal expenditure’ scheme will help address the balance between exempt monies withdrawn and residual fund left behind.  The drawback of this is that the impact of any early IHT charge on the tax free cash and the Income Tax payable on drawings will improve matters greatly for anyone living beyond 75 but will inevitably dilute the returns to beneficiaries if the retiree dies before 75 when the fund would have otherwise been payable free of IHT.

 The following graph shows the impact of taking action early for a retiree aged 66.  The blue line represents the net proceeds available to beneficiaries if the fund is kept until age 75 then goes into drawdown after taking tax free cash.  The red line shows net proceeds if early action is taken.  There is little doubt that the single IHT gift plus normal expenditure route is highly effective beyond 75, especially if the arrangement is started early.  The only difficulty arises if the retiree dies before attaining 75.  This can be simply addressed by the purchase of term assurance in trust to cover the shortfall.  Rates for cover for a 66 year old male per £100,000 of cover are approximately £80 per month for 7 year term (to cover the inter vivos period) and approximately £100 per month for cover to age 75.  This is effective financial planning at its best and makes a good fist of overcoming the pernicious taxes and penalties imposed by Gordon Brown on ASPs in the last Budget. 

 

Assumptions:  Income Tax Rate 40%; Net annual growth rate 6%; 15yr Index Gilt Yield 4.81%;
Drawdown basis 7.5%; Table annuity rate age 75 10.2%; IHT NRB used elsewhere.

 

 

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 6th November, 2007 |
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