EIS Industry Report 2019/20

28 29 RISKS AND DIVERSIFICATION WHY A MIXED PORTFOLIO IS KEY FOR INVESTORS As already discussed, the risks involved in investing in EIS have increased since the 2017 Autumn Budget, when the government looked to sharpen the focus of the scheme onto genuinely risky opportunities. With every pound invested now required to be at risk, the focus is firmly on investing in businesses that may not have secure sources of income or significant levels of assets, and as such EIS investors need to be able and willing to lose all of their capital. As a result, picking the winners is now more important than ever and finding platforms that are capable of ensuring their EIS portfolios both meet the risk to capital criteria and still offer strong returns will likely take up more time for advisers. In this context, diversification will take on a new importance for investors and advisers. While it has always been the case that a diverse EIS portfolio is desirable, this will now become critical to the chances of success. In an encouraging sign for EIS investors, managers appear to be up for this challenge. While some managers have struggled to adapt initially, several other companies have managed to reposition their businesses to develop new and successful EIS offerings. Several funds have launched into the EIS space since the new rules came into force, often run by managers with a track record of successfully investing in growth companies. This means that there is a vibrant and competitive market for investors, while advisers have plenty of choice when considering the portfolio that is right for their clients. While diversification within a portfolio cannot guarantee that an investor will make a return, it does reduce the risk of them losing everything and increase the chances that they will make a profit. And according to the EISA, diversification is also good news for maximising the tax efficient benefits that the scheme can offer. As the Association put it in May 2018, just after the new rules had come into force: “When spread across a diversified portfolio of EIS investments these extremely valuable reliefs become even more useful – particularly the EIS loss relief, which significantly offsets the increased risk that investments which qualify for EIS in 2018 onwards will carry.” 13 Another aspect of ‘diversification’ to take into consideration is in relation to different sectors. In the past, some funds have been heavily focused on a particular sector, but this is also changing as managers go in search of true growth. For example, in April 2016 all energy generation activities were excluded from the EIS reliefs. Therefore, some managers were forced to reposition their portfolios away from this sector. By diversifying across different sectors, managers can mitigate the impact of any future policy changes that may be brought in by the government. EIS AND PENSIONS PROPOSED CHANGES COULD IMPACT INVESTOR APPETITE ANNUAL PENSION CONTRIBUTIONS ALLOWANCE £150,000 £154,000 £158,000 £162,000 £166,000 £170,000 £174,000 £178,000 £182,000 £186,000 £190,000 £194,000 £198,000 £202,000 £206,000 £210,000 £40,000 £35,000 £30,000 £25,000 £20,000 £15,000 £10,000 £5,000 £0 Pension contributions Annual salary Since 6 April 2016, people with a taxable income over £150,000 have had the amount they can put into their pension per year (their annual allowance) restricted. The annual allowance, which is currently set at £40,000, falls by £1 for every £2 of income between £150,000 and £210,000. Above that level, the allowance is capped at £10,000. If a person exceeds their annual allowance, they won’t be able to receive tax relief on any contributions above that limit and will be faced with an annual allowance charge. As a result, there has been demand for alternative tax efficient investments from investors concerned about the impact of the pensions taper on their retirement funds. The annual allowance is considered by many to be a key factor in the growing popularity of both EIS and VCT investments. Writing for FT Adviser in March 2019, Calculus Capital’s Madeleine Ingram explained: “In 2011/2012 the standard lifetime allowance was £1.8m. If this had risen in line with inflation it would be around £2.2m today.” 14 This appears to be supported when looking at the amount of funds raised by VCTs and EISs since the introduction of the taper. In both cases, the amount has increased - significantly for VCTs and enough to halt a downward trend in the EIS sector. While the taper is not the only reason behind this, its introduction for the 2016-17 tax year will have helped the direction of travel. “Strong dealflow, diversification and experience in growth capital investing are key attributes that will drive EIS investor returns.” — JOHN DAVIES, INVESTMENT DIRECTOR, SENECA PARTNERS