A new year, and we could be seeing a new beginning for the UK’s small businesses and the investors supporting them through tax-advantaged investment opportunities.
There are a host of things on the horizon that will affect market sentiment – both in terms of investor confidence and the willingness of small businesses to really go for growth – but by the end of the first quarter, we should at last have some important clarity on where things are going. Certainty and stability remain, after all, the cornerstones of growth and investment.
So here, we take a little look at some of the bigger trends that will set the course for 2020 and beyond.
The ‘B’ word is still very much with us. However, in the short-term, at least, we may be allowed some respite as there is now an almost inevitable drive towards leaving the European Union at the end of January, thanks to the Conservative majority secured at the December General Election.
Regardless of whether you’re a Leaver or Remainer, one aspect of the uncertainty and confusion that has dogged the UK’s relationship with Europe over the past few years looks set to end – and that must be good news for at last providing some sort of certainty to British businesses and those looking to invest in the country’s growth companies.
After all, many experts believe that UK companies’ values are currently depressed because of the uncertainty that has bedevilled Brexit over the past few years, meaning that those making tax-advantaged investments through the AIM market, for example, might enjoy a ‘Brexit bounce’ to their investments come February.
However, if the government is unable to keep to its timetable of negotiating its new trade deals with the EU by the end of the year (a process that is said to average around four years), uncertainty will return.
Whatever happens, the UK’s new trading arrangements with the EU and the rest of the world will no doubt be a key theme throughout the early part of the 2020s, if not well into the latter stages of the decade.
A global context
Even in the event that Brexit is settled conclusively by the end of 2020 (and that remains a big ‘if’), there remain other factors that will have an impact on overall market sentiment and investors’ willingness to part with their cash.
Staying within the British Isles, the clamour for a second referendum on Scottish independence has grown louder since the Scottish National Party (SNP) almost swept the board in the country at last year’s General Election. While Prime Minister Boris Johnson has insisted he will ignore the noise, at some point in the coming years he or a successor may be forced to acknowledge it, which will bring new uncertainty over the future of the UK.
Whether it’s an Enterprise Investment Scheme investment or one done for Business Relief, asset managers may start thinking more carefully about growth businesses based north of the border should the independence drum beat grow louder.
Further afield, macro-economic issues (often related to the US government) will continue to dominate. The early days of 2020 have already demonstrated this, after global stocks first rose on news of a potential thaw in relations between the US and China, only for those same markets to be rocked by the quick escalation of hostilities between the US and Iran.
Given that these events merely encapsulate the first few days of January 2020, it’s fair to say there will no doubt be plenty of further ups and downs affecting the market over the coming years, which points to the importance of viewing an investment as a long-term commitment, where the peaks and troughs of a week or month – or even of one year – can be largely ignored.
Settling into regulation
The past decade has seen plenty of changes to the regulatory environment for investors, managers and investee companies alike.
In the tax-advantaged space, perhaps the biggest changes came with the 2018 implementation of the risk to capital requirement in VCTs and EIS investments, firmly placing these schemes in the growth capital space, with no room for wealth preservation strategies.
Under the recently elected Conservative government, we can expect more support for these schemes and a drive to boost British business in the wake of Brexit. As such, the early years of this decade are unlikely to see any significant changes to the regulatory environment that has allowed EIS and VCTs to flourish.
However, one hangover from the last decade that could well have an impact on the investment community is fallout from the winding up of the Woodford Equity Income Fund late last year. Star fund manager Neil Woodford had long championed smaller and alternative investments, and although the liquidity problems at his flagship fund were not related to tax-advantaged schemes, questions over liquidity have permeated the whole investment market.
There have been plenty of calls for the Financial Conduct Authority (FCA) to act in response to these liquidity concerns, and the Bank of England has also weighed in with proposals of its own, as it warned that open-ended funds have the potential to become a “systemic risk”.
How far any new rules might affect schemes such as EIS or VCTs (in which, unlike open ended funds, fund managers are not obliged to redeem investors units or shares on demand by buying them back), remains to be seen. Nevertheless, the concern for many is that potential investors will be put off investments labelled as higher risk because of the reputational damage done to investments of all types by the Woodford debacle.
And while the prospect of inheritance tax abolition appears to have receded for now (it seems to have dropped off the agenda since Chancellor Sajid Javid said during the election campaign that he might consider looking at it), another change may yet affect tax-advantaged investments.
The tapered annual allowance for pensions became a hot topic last year when it was blamed for preventing top doctors from taking on extra shifts. It was such a sensitive issue for the government ahead of the General Election that the taper was waived for the year, allowing the highest paid clinicians to continue to provide much-needed overtime without it affecting their pensions contributions.
While the new government has said it will review the taper, it could well be abolished not just for top clinicians, but across the board – otherwise the government runs the risk of establishing a twin-track tax regime.
The taper has been credited with encouraging more investments into EIS and VCTs, as high earners seek somewhere to put their cash over and above their annual pension limits, so if it were to be abolished completely, this could have a detrimental effect on the amounts being put into such tax-advantaged schemes.
One trend that seems certain to grow over the next decade is the importance to investors of environmental, social and governance (ESG) policies.
Perhaps the biggest blockage to be dealt with in the investment world in the coming years will be developing a coherent and universally accepted definition of what constitutes an ESG-compliant investment. As the concepts of ESG and so-called impact investing have gained traction with investors, so has the rise in the number of funds and organisations being accused of ‘greenwashing’ their investments. Finding a way to clearly delineate what is and is not within the realms of ESG will be important in gaining the trust of investors.
While EIS and VCT investments can no longer be in renewable energy generation, it’s important to remember that BR investments still can. Furthermore, other ESG investment options, from recycling to medical research, are very much available for EIS and VCT funding. Plus, as these issues permeate more and more into business life, their resonance will increasingly be felt by growth companies even if it is not their primary activity.
Underlining how important environmental issues, in particular, are becoming in the financial world, Bank of England governor Mark Carney told the BBC at the end of 2019 that firms need to change their priorities as the world faces up to the threat of climate change. Signalling that this is now an economic issue as much as an ethical one, the comments show the importance of changing investment priorities to focus on industries and businesses that will have a positive impact on the environment.
That, in turn, will have an impact on the way in which investors view their investments, and how managers can tailor portfolios to suit their increasingly ethically and environmentally conscious clients.
So the 2020s should also see a growth in the transparency of investments, as clients seek out those investment managers with portfolios that not only offer positive returns, but also generate a positive impact on the environment.
Furthermore, the nature of what constitutes an ethical investment will no doubt change over the course of the decade. An example of this may already be seen from a court case in January, in which an employment tribunal decided that ethical veganism can be considered a “philosophical belief” for the purposes of the Equality Act 2010.
Such interpretations will feed into what ESG stands for in the future and how investors respond to this will shape the investments market of the next decade and beyond.
Routes around roadblocks
Despite recent regulatory intervention, alternative finance looks set to continue to grow in importance and value throughout the 2020s, especially at a time when Brexit will see traditional EU funding routes significantly reduced at the very least.
The new government’s support of the new round of Basel standards will only add to the restrictions facing traditional finance routes for smaller, younger and riskier businesses. Given that banks’ reluctance to lend to such businesses has driven the alternative finance market since the 2008 financial crash, these renewed restrictions will only increase the need for such alternative routes to investment.
This is an example of how innovation will help both businesses and investors to adapt to the changing landscape in the years ahead.