As the ban on contingent charging for Defined Benefit transfers goes through the motions of consultancy with the FCA, it looks extremely likely that this prohibition will end up being introduced... Bill Vasilieff looks at the impacts this would have...
In this piece we get some insight into the workings of Discretionary Fund Managers, as Henry Cobbe from Novia’s DFM arm Copia Capital Management looks at ways to shore up portfolio management by:
For those holding investments in a general investment account Capital Gains Tax (CGT) can sometimes feel like a punishment for good performance, but all the same there are definite advantages to taking CGT allowance into consideration. Utilising the allowances to the full helps improve returns and therefore factors into investment decisions, whether that be when crystallising profits or crystallising losses to reduce the year’s net capital gain. Capital losses are certainly worth reporting: with the natural focus being on gains, these are often overlooked, but they do have an upside: if reported, these losses can be used to offset future gains.....
As the ban on contingent charging for Defined Benefit transfers goes through the motions of consultancy with the FCA, it looks extremely likely that this prohibition will end up being introduced. The FCA are clearly very concerned about DB transfers and start from the basis that a transfer is not in the customer’s best interests until proven otherwise. No doubt the FCA recall the pension mis-selling scandal that occurred in the late 1980s and early 1990s, when as many as two million people were wrongly advised to opt-out of occupational schemes and take out personal pensions following the government of the time striving to roll back the state and reduce the burden of tax and regulation in many areas. Paradoxically pensions largely saw the opposite, with a huge increase in regulation and taxation which has had the impact of killing off defined benefit pensions for nearly all but the taxpayer funded public sector.
For those that weren’t around at the time, that scandal involved opting-out of the company pension while still employed, with the result that the company’s future pension contributions to the employee were lost - clearly not good news. It also involved transfers to pension providers where investment growth rates may have made a transfer plausible but the customer was taking on the investment risk. The recent boom in DB transfers is different, as it seems these transfers are too attractive. With the enormous multiples available, sometimes up to 50 times, a transfer looks a very good deal indeed (I know I have taken mine!). Specialist pension transfer advice is critical to ensure the benefits and risks are taken into account when selecting ways to deliver the customer’s outcomes.
The ban on contingent charging is another nail in the transfer coffin as there is a lot of work involved for advisers and very few people will want to fork out for advice which, according to the regulator’s expectations, should result in a recommendation to stay where they are. As a result, people who would have benefited from transferring won’t do so and therefore will actually lose out. I cannot see how the proposed abridged advice option can address this risk to consumers.
The other impact of this ban will be the creation of the thin end of a very big wedge, as we see the last remnants of ‘commission’ disappear. It is not hard to see that once contingent charging disappears and fees are established on DB transfers, the next line of attack will be an extension of the ban to include all investment products. We will have begun to move to a world where advisers live purely on fees; this is something that various regulators have been dreaming of for decades. Whether it is a good thing or not only time will tell, but it looks likely that the ‘advice gap’ will only grow.
The concept of ‘contingent charging’ exists in many guises and in numerous products and services that customers buy, but for financial services it may soon be a thing of the past, and this will have enormous ramifications for our industry.
In this piece we get some insight into the workings of Discretionary Fund Managers, as Henry Cobbe from Novia’s DFM arm, Copia Capital Management, looks at ways to shore up portfolio management by:
What actually delivers performance?
A portfolio’s asset allocation is the key determinant of portfolio outcomes and the main driver of portfolio risk and return. Ensuring the asset allocation is aligned to an appropriate objective is therefore key. Getting and keeping the asset allocation on track for the given objectives and constraints is how portfolio managers can add most value for their clients.
What differentiates portfolio managers?
There are no “secrets” to asset allocation in portfolio management; it’s probably one of the best studied and most thoroughly researched fields of finance.
Perhaps unusually for a competitive service industry, core know-how is not a barrier to entry; anyone completing their Chartered Financial Analyst exam will have a comprehensive grounding in the principles of portfolio management.
What, then, are the differentiating factors for portfolio managers? In my view, there are three important Ps:
Let’s look at each of these in a little more detail.
Quality of Process
To create a quality investment process, managers need a robust set of capital market assumptions for each asset class and the relationship between asset classes. Ideally these should be term-dependent, to align to an appropriate term-dependent investment objective.
To create an appropriate asset allocation, managers need to consider what their objective is. Is it risk-adjusted returns? If so, an asset-optimised approach makes sense. (The bulk of retail multi-asset strategies take this approach). Is it to match future liabilities? In this case, a liability-relative approach would make sense. (This is more akin to how a defined benefit pension scheme is managed). Alternatively, does it have the objective of targeting a volatility level or band, or a level of income distribution?
Managers also need to design a set of constraints – risk budget, fee budget, minimum and maximum position sizes, portfolio turnover constraints and counterparty considerations.
Managers need to make implementation decisions as regards how they access particular asset classes or exposures – with direct securities, higher cost active/non-index funds, or lower cost passive/index funds and ETFs. Key considerations in this respect are fund level due diligence on underlying holdings, concentrations, round-trip dealing costs and internal and external fund liquidity profiles.
Quality of People
Whilst we believe strongly in the deployment of technology to assist managers in designing, building and managing portfolios, this doesn’t mean we don’t simultaneously see people as core to a business. Investment managers must invest in their people to build on both the quantitative skills that are necessary in finance and the communication skills that are necessary to interact effectively with advisers and their clients. It’s people that make up a brand, and clients measure performance as much on client service as on returns.
Quality of Proposition
It’s important that a manager knows where their own expertise lies. We believe there’s little value in reinventing the various wheels that need to turn within a proposition just for the sake of it. There is, however, tremendous value in bringing together best in class components in such a way as to create a proposition that’s robust, repeatable and proprietary.
There are few firms, if any, that can reinvent all their own wheels, building an end-to-end proposition entirely in-house; choices need be addressed: we can create our own capital market assumptions, or we can use third party ones for risk, return and correlations; we can use our own optimisation tools, or we can use third party ones to create a strategic asset allocation; we can use our own tactical asset tool, or we can use third party signals or “regime indicators”; we can use high quality third party index funds to access asset classes in a way that is diversified, transparent, liquid and low cost; we can use our own or third party analytics and reporting to feedback performance information to advisers and their clients.
It’s the quality of the choices made around proposition that differentiate portfolio managers, and in this respect it’s important to remain agile and adaptive to a rapidly changing landscape in asset management and technology.
Bringing it all together
The objective for investment managers is no longer about “pushing” one product or another. It should be about providing solutions that help address a specific adviser need.
We ask ourselves: What problem is the adviser trying to solve for their client? We seek to help them do that in a way that’s robust, repeatable and evidence-based, so that all of us - managers, advisers and their clients - can sleep well at night!
The real secret, in the end, is that there are no secrets. Good portfolio management is about focusing on what matters with informed common sense.
For those holding investments in a general investment account Capital Gains Tax (CGT) can sometimes feel like a punishment for good performance, but all the same there are definite advantages to taking CGT allowance into consideration. Utilising the allowances to the full helps improve returns and therefore factors into investment decisions, whether that be when crystallising profits or crystallising losses to reduce the year’s net capital gain. Capital losses are certainly worth reporting; with the natural focus being on gains, these are often overlooked, but they do have an upside: if reported, these losses can be used to offset future gains.
Calculating Gains & Losses
When crystallising investments the proceeds raised are matched against an acquisition cost to calculate the gain or loss. This acquisition cost is derived using three matching rules:
These matching methods are applied in the order shown above, and sometimes multiple matching methods will apply. For example, if 100 units are sold, 10 re-purchased on the same day and 10 purchased the following week, the sale would initially be matched against the 10 units purchased on the same day, followed by the 10 units purchased a week later, then finally the remaining 80 would be matched against historic purchases using the pooling method.
The purpose of the Same Day and 30 Day rules is to prevent artificial crystallisation of gains to maximise the annual CGT allowance whilst resetting acquisition cost so that future gains are decreased.
Distributions are treated as income for tax purposes, so if gains/losses were not adjusted for these then there would be a risk of double taxation:
Notional distributions occur when, rather than paying out income to investors, the distribution is automatically reinvested and the value is retained within the fund. To avoid paying tax on both the distribution and the added value via CGT, the notional distribution is treated as allowable expenditure for CGT purposes. The original acquisition cost is increased in line with the distribution, meaning the increased value arising from the distribution is not subject to CGT.
Units purchased between the ex-dividend date and the dividend payment date are purchased at an inflated price. This inflation is caused by the upcoming dividend payment, after which the price will drop as shown in the below graph:
This equalisation payment is treated as a return of capital for CGT purposes, and therefore is not subject to gain or loss. To facilitate this, the acquisition cost is lowered by the amount of the equalisation payment.
Allowances & Rates
The personal capital gain allowance is the net amount of capital gains an individual can make tax free. At the turn of the last decade this stood at £10,100 and has steadily increased to the current level of £12,000. The allowance for a trust has always been half that for an individual.
The rate at which CGT is calculated on gains over and above the allowance depends on an individual’s total taxable income, with basic rate tax payers paying 10% and higher rate taxpayers 20%. When selling property, the rates are slightly higher at 18% and 28% respectively.
Investor A earns £40,000 p.a. and made a £27,000 gain on their investments.
The allowance of £12,000 brings the taxable gain down to £15,000.
Before taking the gains into account, Investor A has £10,000 before they reach the £50,000 higher rate bracket, therefore £10,000 is taxed at basic rate (10%) and the remaining £5,000 is taxed at the higher rate (20%).
£10,000 @ 10% = £1,000
£5,000 @ 20% = £1,000
Total CGT payable = £2,000
Why record losses?
Throughout the year all gains and losses made contribute to the final net position that is reported to HMRC. If the net position is an overall loss for the year, it might be assumed that there is no benefit in reporting. In fact, capital losses that are recorded within a tax year can be carried forward indefinitely to offset any gains in future tax years that are above the personal capital gain allowance.
As you can see in the above table, one year of poor performance can actually provide significant benefits and savings in future years. In this example, assuming this is a higher rate tax payer, they have saved £1,000 across two years (20% of £5,000) by reporting their losses.
Using the Novia CGT tool can help take the stress away from calculating all of the above. It lets you view gains and losses of each disposal over tax years or specified date ranges. It also allows you to drill into each disposal, providing a breakdown of the acquisitions it has been matched against and which matching method has been used. You can also drill into the Acquisitions to view any adjustments that have been made as a result of distributions.
Finally, you can run an unrealised gains report; this will show all the investments currently held and the original acquisition cost along with the potential gain/loss based on the latest available price. This report can be used as a guide when trying to determine how best to sell down to utilise the CGT allowance.