Sententia articles September 2020

In this issue

Helping your clients get a slice of the ETF cake

ETFs celebrated their 30th birthday in 2020, with the first successful ETF having been launched in Canada in March 1990. The global ETF market is growing fast, reaching $6.35 trillion at the end of December 2019 – a very significant rise from $4.3 trillion in 2017...

To tax or not to tax – what does Rishi have in his hat for the November budget?

The last six months have seen an unprecedented but much-needed increase to the levels of government spending in the UK, to rise to the challenges of Covid-19. The image of Rishi Sunak taking to the stand to announce monumental measures to try to support the economy, businesses and workers is almost as memorable as Boris addressing the nation to tell us we were locking down...

 

Helping your clients get a slice of the ETF cake

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ETFs celebrated their 30th birthday in 2020, with the first successful ETF having been launched in Canada in March 1990. The global ETF market is growing fast, reaching $6.35 trillion at the end of December 2019 – a very significant rise from $4.3 trillion in 2017.

It’s easy to see their appeal; by making it possible to track an index, ETFs effectively allow investors to trade market indices on an exchange, whether that be a broad market index like FTSE-100 or a sector index such as Global Infrastructure. ETFs combine the performance of the traditional tracker funds with the flexibility of ordinary shares.

In the early days, ETF investing was – unfortunately - the preserve of the rich due to high unit prices. Today the high unit price remains, but this no longer needs to be a barrier. With Novia leading the way, a small number of platforms have introduced fractional trading, so that it is now possible to invest in ETFs without risking a drag on performance through holding additional cash, when buying full units isn’t possible. At Novia we have calculated that fractional trading can save as much as 1100bps* in client fees over a ten-year cycle, which would be an additional return of £11,267 on a client’s £100,000 portfolio over a 10-year period.

So, whilst proven demand was a driver for platforms and DFMs to add ETFs to their offering, the real key for using ETFs on platform has been fractional trading. This is why we are pleased to have been the first platform to offer fractional trading of ETFs back in 2017. At last the high unit price of Exchange Traded Funds was not a barrier for smaller investors.

With this barrier gone, c2000 ETFs listed on the London Stock Exchange become available; how do you select the right ETFs for your client?

ETFs come in many flavours

There are various types of bond, such as:

Bond ETFs - These are usually used to generate cash from interest on the individual bonds held within the ETF. Bonds help provide stability and give defensive characteristics to a portfolio. Bond ETFs invest in a specific basket of debt securities such as corporate bonds, sovereign bonds and high yield bonds as well as providing granular exposure in the duration.

Specific maturity ETFs – These ETFs invest in bonds of specific maturity profiles (0-5 years or 15 year+) providing investors precision investment tools to target a specific bond duration in a portfolio.

Cash proxy ETFs – These ETFs invest in Ultra-short maturity investment grade bonds which have very low sensitivity to interest rates and deliver slightly better than cash returns but have very low volatility.

Stock ETFs – These are usually intended for long term growth and comprise stocks. Equities help deliver higher returns than bonds over the long term but carry higher risk.

Sector ETFs – These invest in a specific sector such as industrial, mining, healthcare, technology, energy, consumer goods and many others.

International ETFs – These may include investment in a particular country or a geographical area.

Thematic ETFs – These ETFs invest in stocks which are expected to benefit from megatrends which are powerful transformative forces that are changing the global economy like Cybersecurity, Robotics & Automation, Clean Energy, Agriculture, Water, Ageing Population and many more.

ESG ETFs – ETFs that hold ESG compliant stocks or bonds for investors with an ESG preference.

Investors can also use ETFs to invest in alternative asset classes like gold, property, infrastructure, private equity and commodities. Commodity ETFs allow a chosen group of commodities to be bundled into a single investment.

Within these many options come further market exposure considerations:

  • Type of debt - corporate versus sovereign exposure, credit rating and duration
  • Size tilt (large cap, mid cap, small cap)
  • Style (income vs. growth)
  • Factor based or Smart Beta (yields and durations for bonds, dividend yields for equities). These invest in stocks that display certain investment characteristics like price momentum, low volatility or quality
  • Currency exposure (Hedged or Un-hedged)

 

ETFs now offer investors, advisers and discretionary managers a large number of options to construct portfolios that contain specific exposures, helping them express their investment views and philosophy cost-effectively. ETFs, being rules-based investment funds, also give the investor assurance that they will not deviate from their mandate and will continue to deliver on the expected exposure with high precision. With qualities such as these, it’s no surprise that ETFs have grown by over $2 trillion in the last three years nor that the trend is expected to continue.

https://etfgi.com/news/press-releases/2020/01/etfgi-reports-assets-global-etfs-and-etps-industry-which-will-turn-30

 

*Novia internal calculations for a £100,000 portfolio invested in 10 ETFs, assuming 8% growth pa and 16% volatility.

 

To tax or not to tax – what does Rishi have in his hat for the November budget?

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The last six months have seen an unprecedented but much-needed increase to the levels of government spending in the UK, to rise to the challenges of Covid-19. The image of Rishi Sunak taking to the stand to announce monumental measures to try to support the economy, businesses and workers is almost as memorable as Boris addressing the nation to tell us we were locking down.

For many, Rishi came across well: a strong figure, commanding respect, dedicated to the task at hand. That being said, the measures put in place to support businesses and employees have come at a great cost to the Treasury. It was estimated that the furlough scheme would cost £14bn a month, and thus far is said to have cost roughly £40bn. Public sector debt has now hit more than £2 trillion for the first time in history. This leaves the government in the difficult position of trying to continue to support businesses, workers, and the economy whilst also recouping money that has been spent.

There’s been a lot of speculation about how Rishi might try to use tax rises to collect some of this money. Where formerly the conservative government may have preferred to cut spending rather than increase taxes, the unprecedented amount of spending this year makes it a very real possibility that tax rises will come into play.  Speculation has focussed largely on the likelihood of increases to i) Capital Gains Tax (CGT) on assets and/or property, ii) Corporation Tax or iii) National Insurance contributions for the self-employed. So, what do these potential changes mean?

Corporation Tax

It's rumoured that one of Rishi’s proposals is to increase Corporation tax from 19% to 24%, and this seems one of the more likely outcomes. Corporation tax in the UK has been reduced consistently since the 90s, when it was at 33%. Even during the last decade it has reduced from 28% to its current level of 19%. In that sense, there is some wiggle room. But while the older, more established businesses in the UK would have a recollection of times of higher corporation tax rates, newer and smaller businesses will not be used to budgeting for these amounts. A rise would also be particularly unwelcome for those industries that we see really are struggling such as aviation and hospitality. There will of course be pressure to give businesses as much support as possible during these difficult times.

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Reduction in Corporation Tax since the 90s

Another concern will be that this is a time when the UK ought to remain competitive in Europe and globally, particularly with Brexit around the corner. Several countries that have much lower corporation tax rates have already been able to attract businesses concerned about Brexit. While the UK remains largely on a par with Europe, and more cost effective than countries like France and Spain where the rates are 32% and 25% respectively, it must be remembered that some countries still remain more appealing to businesses, such as Ireland where the rate is 12.5% as a comparison.

Capital Gains Tax (CGT)

Another potential move for Rishi is an increase to Capital Gains Tax (CGT). CGT is applicable upon sale of assets including shares, investments, or real estate. The rate at which CGT is paid differs depending on your income tax band and the type of asset. For shares and investments, you’ll pay 10% on any gains above the allowance if you’re a basic rate taxpayer, and 20% as a higher rate taxpayer. Similarly, for real estate you’ll pay 18% and 28% respectively.

There’s been speculation about a rise in CGT rates, as Rishi commissioned a review not long after the start of the pandemic, triggering opinion that he might be looking to increase rates to increase income. CGT like Corporation Tax has been reduced over the years and so again there is wiggle room to increase it back to former rates. In the 80s CGT was paid at a rate of 30%, and during the 90s and early 00s it was paid at an equivalent rate to income tax bands.

There is a popular theory that if Rishi were to make changes to CGT rates, this would come in the form of a return to a previously used model where it is equivalent to income tax rates. Such a system has not been in place for several years so might be a shock to investors, particularly those who are higher rate taxpayers. However, it is a possibility and would certainly generate a good amount of income to help claw back Covid-19 spending.

Key Facts from 2018-19 tax year:

  • The total CGT liability was £9.5bn from 276,000 taxpayers. This was realised on £62.8bn of chargeable gains.
  • Most of the above figure comes from a small number of taxpayers who have made gains of over £5 million. This represents roughly 1% of CGT taxpayers every year.
  • In 2018-19 the number of taxpayers decreased, with 13% of taxpayers producing 42% of the liability.

Source: https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/908667/CGT_National_Statistics_Commentary.pdf 

National Insurance

National Insurance has been around since the National Insurance Act in 1911. Although it has adopted many different guises since its introduction, the purpose remains the same as it ever was – to provide everyone with access to essential state benefits such as the State Pension, Maternity Allowance, Job Seeker’s Allowance etc.

National Insurance is importantly paid by both employers and employees, and therefore effects both parties in the chain. It is taken out of PAYE each month and many have started to regard it as an addition to income tax. There are four classes depending on your type of work and voluntary contributions. Most employed people will pay Class 1, which is currently 12% of your weekly earnings between £183 and £962 (2020-21), and 2% of your weekly earnings above £962.

In the discussion of potential tax rises the rumour is that Rishi is considering an increase to Class 4 contributions for the self-employed. Currently Class 4 are paid at a rate of 9% between the lower profits limit of £9,500 per annum and the upper profits limit of £50,000. There is talk of increasing this to 12%, which would bring it in line with Class 1 contributions for the employed. National Insurance contributions have been looked at in previous budgets with Philip Hammond having announced an increase in his 2017 budget, but later doing a U-turn.

An increase in NI contributions for the self-employed is a possibility. This has been looked at before and would be an easy way of bringing in more revenue, and could also be dressed up as fair, being brought in line with contributions for the employed.

Needless to say, Rishi has several difficult decisions ahead of the November budget. Before all this we might have expected a Conservative government to cut spending to save money, but the current circumstances are so unprecedented that suddenly tax increases are on the table. If this doesn’t take the form of a a rise in existing taxes, it could be that they decide to it would be more efficient and effective to introduce a new way of collecting the money.