This article is taken from Investor Chronicle where Intelligent Partnership was featured, click here to read the original article.

With growing numbers of people facing inheritance tax (IHT) bills, there has been a surge in investment products designed to mitigate it, using business relief. These fall into two main types: managed portfolios composed of Alternative Investment Market (Aim) shares and portfolios that hold shares in unquoted companies.

Aim portfolios

You can create a portfolio of investments that qualify for business property relief (BPR) by purchasing shares in eligible companies trading on Aim. However it can be difficult to tell whether companies qualify for BPR, especially as this can change suddenly, for example if the company decides to list on another market. To avoid this hassle you can buy one of the managed Aim portfolios run by specialist providers. These portfolios typically hold 20-30 shares and employ teams of tax experts to check that each share qualifies for BPR.

Daniel Kiernan, research director at Intelligent Partnership, says that although Aim is often volatile the managers of these portfolios focus on reducing volatility. They to do this by investing in businesses that operate in markets with high barriers to entry, are cash generative and are at least £50m in size.

“It is possible to find well-established, high-quality companies earning steady returns and paying steady income to their investors, which are good candidates for an IHT portfolio”

“Aim has a reputation for being volatile, but that’s driven in part by initial public offerings (IPOs), and oil, gas and resources companies which are very tied into commodity prices,” he says. “It is possible to find well-established, high-quality companies earning steady returns and paying steady income to their investors, which are good candidates for an IHT portfolio.”

Colin Low, managing director of Kingsfleet Wealth, adds that his clients’ Aim portfolios have demonstrated high performance in recent years. The Aim providers his firm uses include Octopus Investments and Brooks Macdonald.

David Smith, director of financial planning at TilneyBestinvest, adds that part of the reason Aim portfolio managers have performed well is their use of old-fashioned stockbroking techniques. “They actually go out and meet the chief executives, have a good look at the company and understand what’s under the bonnet – both the threats and the opportunities,” he says.

He uses Aim providers for clients such as Canaccord Genuity, Downing and Stellar.

“An increasing number of Aim portfolio companies offer downside protection, which makes them even more attractive,” adds Mr Smith. “Stellar, for example, offers 40 per cent loss insurance on death [within two years], which is a massive attraction because the big risk for our clients is loss of capital. If they can insure a loss of up to 40 per cent, that’s equivalent to what was going to be saved in inheritance tax.

But despite the recent good returns from these portfolios, Aim shares are still one of the riskiest investments. You need to make sure such a portfolio is suitable for you and be able to absorb potentially big losses.

“Aim companies historically have a limited or lumpy track record in terms of profitability,” says Mr Smith. “It’s also an illiquid market, so if many Aim brokers happen to hold the same share, which is quite possible, and sell it at the same time, that would have a massive impact on the value of the share.”

Conversely, Aim providers piling into the same companies and creating a bubble is also a risk.

“Even though there are something like 1,000 firms listed on Aim and 50-75 per cent might be BPR-qualifying, the BPR-qualifying companies that actually meet the investment criteria managers apply shrinks the universe,” explains Mr Kiernan. “If all this BPR money is flowing into Aim-traded companies, it might be elevating the valuations.”

Unquoted trading companies

Some BPR products comprise portfolios of unquoted trading companies that qualify for BPR and are often called inheritance tax solutions, portfolios, or services. As these are regular limited companies you can research them and get access to their accounts at Companies House, adds Ben Yearsley, investment director at Wealth Club.

The providers of these products use different strategies when selecting assets for their portfolios. Some only invest in specific projects, and these are often in renewable energy, which receives government subsidies. An example would be an investment in the installation of a solar site that will run for 20 years.

“These projects have very clearly defined returns, which means there’s a lot of certainty around them, although of course they’re not risk-free,” says Mr Kiernan. “But that also means a lower level of return as they typically have a capital preservation mandate.”

Several providers also employ an asset-backed loan financing strategy. “What these normally do is use investors’ money to buy an asset for a business which will pay them a rent,” explains Mr Smith. “For example, they’ll make an interest paying loan to a company that’s building a hotel. If the loan doesn’t get repaid they’ll have security on the hotel.

“Most of these schemes expect to generate a return of between 4.5 per cent and 5 per cent. The underlying business model is relatively low risk, assuming the asset backing the deal has a lot of equity in it. So even if the deal goes wrong, the investors should have an asset worth more than enough to be able to recover whatever was owed to them. These schemes tend to have dozens of loans in them, spread across various investors so that no one has too much money in any one basket.”

The providers Mr Smith has used for clients in this space include Puma, Rockpool, Octopus and Stellar.

In common with Aim portfolios, some of these schemes also offer insurance alongside BPR. These include Downing, which covers the first 20 per cent of losses at time of death for at least the first two years. And Foresight will pay 40 per cent of the investment to a beneficiary if an investor dies within the first two years of buying the product.

But although the strategies employed to invest in unquoted companies sound good, this area is still open to the risks of an economic downturn and has not been stress-tested, warns Mr Smith.

Mr Low says you must understand what the underlying assets are and how this affects their risk profile, so it is important to do research on these and find out exactly what you would be investing in.

Key considerations when choosing a BPR product

Risk

Your risk profile and personal circumstances are key to figuring out which BPR investment is suitable for you. Project-specific, private equity solutions might be more appropriate for people in their 80s and 90s who are concerned they may not live longer than two years and want an IHT solution with less risk.

Mr Low favours BPR strategies that target 3-5 per cent a year via unquoted companies for these types of clients. The providers he uses for this area include Foresight and Time.

“For people just looking for capital preservation and inflation-matching returns these are a great way of holding assets [while still allowing] you access to your funds,” he says.

Aim portfolios tend to be more appropriate for younger investors with a higher risk tolerance. “These could suit an investor in their 50s or 60s with an individual savings account (Isa) portfolio who wants to do some estate planning, but not forego potential growth or access to their money,” says Mr Kiernan. “So they could roll the money in their Isa into a BPR-qualifying Aim portfolio within an Isa.

“Another option would be private trading companies, which give you a higher level of return but a little less volatility than an Aim portfolio.”

Mr Low also advises you scrutinise a provider’s track record. “A good manager will screen out individual company risk,” he says. “You want a manager who is really going to interrogate the underlying assets to ensure they are entirely suitable both in terms of qualifying for IHT and for long-term investing.”

Cost

It is important to look at costs and shop around for the best option. But comparing costs can be difficult as different providers apply fees in different ways. For example, some BPR investment products apply initial charges, annual management charges (AMC), and exit, dealing or performance fees.

“As these can be long-term products an AMC will compound over time, so don’t go for something with a low initial charge but a high ongoing charge, because if you’re invested in it for 10-15 years, that’s really going to add up,” says Mr Kiernan. “You may be better off paying a high initial fee and lower ongoing charge.”

Some products don’t charge an AMC because they take fees from the companies they invest in. But Mr Kiernan says: “You have to look at all the charges in aggregate. Where the companies take fees from the investing company, while that may look good because it’s not coming out of your pocket, you have to remember that it’s having an effect on the value of that company and therefore the value of the underlying portfolio.

You can do a free trial of tax-efficient investment products such as BPR, Enterprise Investment Schemes (EIS) and venture capital trusts (VCT) at intelligent Partnership’s sister company www.micap.com.

But Mr Low argues that you are often better off using a financial adviser when investing in BPR, both to check the suitability of the scheme, but also for better fees. “Some managers actually cost more if you go to them directly rather than via an adviser,” he explains. “This is the case with Octopus, which wants people to go through advisers because they believe those people will come better qualified and the funds tend to stick longer.”