Getting it right and avoiding the zombies is a big challenge, but investing in Aim stocks can still make a lot of sense, says David C Stevenson.
Like most people in Britain, I'm a huge fan of the good old tax-free individual savings account (Isa). However, as a general rule I'm fairly cautious about most other tax-efficient forms of investing, especially those built around bespoke investment products or funds. This caution is inspired by two observations. The first is that many of these structures come laden with inexcusably high fees and upfront charges. Secondly, by and large these products and funds tend to be heavily "advised".
In other words, they usually have to be purchased via an independent financial adviser (IFA) or a financial planner who has the benefit of a comprehensive picture of the client's financialstatus, and especially their tax liabilities.
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The good news, however, is that competition has been hotting up in this area. More direct platforms where you can invest in these products yourself such as Tilney Bestinvest and Wealth Club have started offering products as varied as enterprise investment scheme (EIS) funds, venture-capital trusts (VCTs), and business property relief vehicles. Rising competition means that standards have undoubtedly improved, costs have come down somewhat, and providers have produced more innovative products.
How to save and bequeath tax-free
And one market in particular where we've seen real progress is in Isas that invest in Aim stocks. Aim shares have been Isa-eligible since August 2013, and what's particularly interesting about these stocks is that some of them benefit from the aforementioned business property relief (BPR) tax benefit. This particular tax boondoggle provides relief from inheritance tax (IHT) on the transfer of relevant business assets at a rate of 50% or 100%. In other words, if you build up a pot of these Aim stocks, you can pass on an Isa to your heirs free of IHT.
At this point, many readers might think: "Hang on a minute, I thought that not only were Isas tax-free but that I could pass them on tax-free?" That's largely correct, except for one fly in the ointment. On your death, your spouse has the opportunity to take your Isa lump sum and then re-invest it (plus adding their own cash). But this only works for your spouse or civil partner not your girlfriend or boyfriend or your children. Also, the IHT issue isn't dodged when your spouse passes away, their estate will be liable (assuming it's bigger than the IHT allowance).
Alternatively, you could set up a trust, liquidate the assets in your Isa, and then gift them into the trust. The problem with this option is that you no longer have control over your money, and you stop getting the Isa benefits of tax-free growth and tax-free income. Oh, and you need to live for seven years after the transfer to the trust for the whole set up to work.
This is where an Isa full of Aim stocks comes in. If you quietly go away and build a portfolio full of Aim stocks that benefit from BPR you could in fact dodge all that IHT, and still keep control over who you give the money to. The catch is the fact that you have to pick all those Aim stocks and keep an eye on them ie, you need to become a smart stock picker. And the problem with that is that Aim is really rather imperfect.
Dodging the zombies on Aim
It's supposed to be London's great venture market where fast-growing, earlier-stage businesses raise capital and become world beaters. And there are businesses such as online fashion dynamo Asos that absolutely fit the bill. Sadly, there are many more utterly pointless vehicles, which are worth a few million but have no real, sensible assets. In particular, Aim has played host to a long line of resource special purpose vehicles that are the corporate equivalent of zombies.
To say that stock picking in this small/micro-cap stockmarket is "challenging" is, I think, an epic understatement especially if you are in your 70s or 80s and worrying about your tax affairs. It's also important to point out that not all Aim stocks are eligible for BPR.
Getting a professional stock picker in
However, those Aim stocks that do tick the right boxes become free of any IHT liability after two years, as long as they continue to qualify for BPR and you still hold them on your death. Now, I have to be honest and say I can't quite fathom why this tax structure is actually in place it sounds like one of those tax breaks that sounded good in a focus group, but which could end up costing the wider tax-paying population a fair bit of money for questionable benefits in terms of enterprise incentives.
But policy-based qualms notwithstanding, I can see why an Aim Isa, managed by a professional fund manager, could make sense, especially for older investors. You get a flexible investment portfolio that's simple to understand, which could provide tax-free income for as long as you live. And you stay in control ie, you can close it whenever you want. Hence the growing market for Aim Isas.
So how do these Aim funds work? In essence you pay a specialist fund manager to build the portfolio for you. He or she checks all the BPR stuff, makes sure that the business isn't one of the no-hoper zombies I mentioned earlier, and then hopefully shortlists the best stocks that might actually grow in value. Aim Isas tend to come in two forms income-based structures where a dividend of as much as 3% per year is paid; or a straight capital gains growth vehicle.
Many of the fund management houses specialising in tax-efficient structures places such as Octopus, Unicorn and Downing now boast their own Aim Isa. The minimum annual investment is usually £15,240 (the maximum annual allowance which goes up to £20,000 from 6 April this year), and you'll probably have to pay an initial charge and a dealing fee even if you use a direct-to-investor platform.
The initial charges can be anything from 0.75% to 4% (yes 4%!); dealing fees run between 0.5% and 1%; and annual management charges come in at around 2% a year plus VAT. As if all that wasn't bad enough, you might even be hit with an exit charge as well (not common, I admit, but sadly still in evidence with some managers so check before you invest). There is no getting away from it these fees are very much on the high side.
Expensive, but potentially worth it
So what do you get for your money? Ferret around inside the fairly concentrated holdings and you'll find some familiar names from the upper echelon of Aim businesses outfits like Scapa, CVS, Craneware, Renew Holdings and Abcam. Performance-wise, it's difficult to track all the players in the sector as there's no independent outfit (to my knowledge at least) tracking numbers against a benchmark and the sector is relatively young.
Take one example: Octopus is traditionally a big player in this space and its performance is mixed against the benchmark. It's been running an IHT-focused Aim fund management scheme outside of an Isa for many years now. That service sometimes beats the Aim index (it did in 2015, 2013 and 2012), while in other years it underperforms (like last year). Overall, since inception in June 2005, it is up 193% through to the end of 2016. Most of its rivals, such as Downing and Unicorn, by contrast, have only one or two years' track record.
There are also some relatively unfamiliar (at least to me) names, such as Stellar (with its Stellar 40 portfolio). Over its nine years of managing IHT Aim money, it's recorded gains of 115% compared with a loss of 18% for the Aim All-Share index.
Another fund manager with an alternative angle is Time Investments. Time only sells its Aim Isa via an IFA, so you can't buy direct. However, the company has come up with a clever take on the portfolio construction idea. It's taken the idea of passive, index-tracking funds (such as exchange-traded funds) and built a strategy that uses quantitative criteria to pick a selection of "quality" Aim stocks you could call it "smart beta" for Aim.
This has the advantage of reducing what I call "idiosyncratic fund manager bias" (ie, the risk of backing a fund manager who picks all the wrong stocks) and reducing costs. The initial fee for this is 1%, with an annual management charge of 0.8%.Over the next few months I'll be digging a bit deeper into this slightly exotic sector to find out which funds might make the most sense, but it's definitely an area that should be on your radar.
David Stevenson has been writing the Financial Times Adventurous Investor column for nearly 15 years and is also a regular columnist for Citywire.
He writes his own widely read Adventurous Investor SubStack newsletter at davidstevenson.substack.com
David has also had a successful career as a media entrepreneur setting up the big European fintech news and event outfit www.altfi.com as well as www.etfstream.com in the asset management space.
Before that, he was a founding partner in the Rocket Science Group, a successful corporate comms business.
David has also written a number of books on investing, funds, ETFs, and stock picking and is currently a non-executive director on a number of stockmarket-listed funds including Gresham House Energy Storage and the Aurora Investment Trust.
In what remains of his spare time he is a presiding justice on the Southampton magistrates bench.
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