This week City Wire highlighted that Octopus EIS 2 has suffered a 42% drop in value.

The fund raised £18.3m from 170 investors and closed to new investment in January 2011. The money was then invested in ten unquoted film and music rights companies between February and April 2011. The shares are currently valued at 58p, down from the issue price of £1, a 42% paper loss.

The Damage

Let’s say for the sake of argument that the investors do get out today at 58p per share, what would be their actual return after claiming the EIS tax reliefs?

The minimum subscription amount was £50,000. With the upfront Income Tax Relief of 30% the share would have only cost the investor £35,000, so the actual loss equates to £14,700.

Investment losses in EIS can be used to offset taxable income in the year the shares were disposed of, up to 40% of the loss (for higher rate tax payers) – in this case it is £5,880.

This results in a total loss to the investor of £8,820, still an 18% loss, but obviously much better than the original 42%.

Note that this is before considering fees and charges (however, Octopus has agreed to wave many of the fees in this fund).

This is a good demonstration of why the EIS tax reliefs are in place – to lessen the blow of the significant losses that are possible investing in small, unquoted companies.

Considerations 

Some commentators are upset because the scheme was promoted as low risk, or as capital preservation focused investment. Our view is that although the fund was marketed as lower risk than other EIS investments, ANY EIS should always be considered a high risk investment, simply because of the nature of the underlying asset class.

EIS are usually only suitable for sophisticated and high net worth investors, with a healthy risk appetite and capacity for loss. The high minimum investment level reflects this, and the very concentrated and specialist nature of the underlying assets should also flag that this is not suitable for risk adverse ordinary retail investors.  We think that this particular fund should have been selected as part of a diversified portfolio of EIS investments, so that these losses hopefully do not lead to too much detriment for investors.

We will continue to monitor this and see how much value Octopus can manage to extract from the portfolio.