Tax Efficient Digest – 20 July 2018
When I think about investment portfolios, certain phrases spring to mind: hedge your bets; don’t put all your eggs in one basket; and variety is the spice of life…
Spreading your money across different investments helps protect you against unforeseen market events. In other words, diversification should reduce the risk, potentially making these returns more consistent.
But while the concept of diversification is not new to investment, it seems many private investors are not diversified enough.
According to the findings of this year’s LGT Private Banking Report, there’s not much difference between one high-net-worth private investors’ portfolio and the next. Rather than branching out, many of these investors are sticking with what they know – staying faithful to their usual asset mix of cash, equities and bonds.
Let’s talk about risk
The LGT study also revealed that the risk seen in investment portfolios doesn’t necessarily match investors’ appetites for it. In theory, a risk-averse investor should have a low-risk portfolio, while an investor happy to take risks should have a higher-risk portfolio.
However, the study showed this is not always the case: 56% of respondents willing to take risks class their portfolio as low to medium risk, while 51% of risk-averse respondents consider their portfolio risk medium to high.
At this point I should say, while diversification is important it only reduces risk up to a point. For example, you can’t simply diversify away systematic risk (aka market risk) because this kind of risk affects the market as a whole, not just a particular stock or sector. Events such as political turmoil, changes in interest rates and recessions are all classed as market risks. Market risk is impossible to avoid but can be hedged against if investment portfolios include a variety of asset classes.
That said, systematic risk should not be confused with systemic risk, which refers to a trigger within a company that has the potential to cause severe instability or collapse an entire industry. You just have to cast your minds back to the 2008 financial crisis to see systemic risk in action. Companies considered ‘too big to fail’ (Lehman Brothers, ten years ago) are systemic risks. Again, hedging your bets across a number of sectors can help you manage this risk.
Keep your options open
So, if diversification can be used to manage risk, why aren’t investors diversifying more?
One of the reasons investors are shying away from greater diversification could be that they are simply not familiar with all of the opportunities available to them. Away from the usual array of stocks, shares, pensions and ISAs lie a range of government schemes that help small UK businesses grow.
Another reason for why diversification is often overlooked is the time and cost it takes an investor and/or their advisor to research and spread smaller amounts across multiple investments and fund managers. However, with the rise of platforms and financial technology developments, it is becoming easier to diversify by investment and manager, for example, multi-manager funds.
Enterprise Investment Partners offers opportunities within leisure and hospitality, sustainable energy and start-ups. For example, Imbiba Leisure EIS Fund and Epicure SEIS Fund cover the innovative food, drink, leisure and hospitality market and help investors build a diversified portfolio. In partnership with Startup Funding Club, SFC EIS Growth Fund targets scale-up investment opportunities across all sectors. Meanwhile, Guinness Sustainable Infrastructure Service invests in sustainable energy companies to provide stable, long-term and index-linked cash flows by providing Inheritance Tax Relief (IHT)
Spread your investment to manage risk through diversified investing
In my view, the higher the risk, the more important diversification becomes. By spreading your investment across different companies, assets, and managers you will hopefully be rewarded with more consistent lower risk returns. This means opting for a generalist approach across ideally 20 companies and perhaps 2 or 3 managers. The best way to achieve this is to invest across a range of opportunities with a focus on different sectors and managers, and ensuring the manager is investing across three to ten companies.
Understanding the full range of options open to investors is a crucial part of the investment process. For more information about our open investments and how to go about diversified investing, get in touch with the team today.
Christian Elmes, Partner
Christian Elmes trained at PwC and qualified as a chartered accountant in 1999, before moving to Morgan Stanley (2000-2002) as Associate in the Investment Banking Division (IBD).
He was appointed Director of Finance, Teather & Greenwood Investment Management in 2002 and moved with the Tax Efficient Solutions team to Smith & Williamson in 2004, becoming Deputy head of the department. He left to co-found Enterprise in 2011.
Over the last ten years, Christian has been responsible for developing a number of tax efficient products, particularly Enterprise Investment Schemes (EIS). He is able to lead on tax efficient product development from inception through to completion, because of his financial and tax background and commercial experience.
Christian is competent across a broad range of sectors including, leisure and hospitality, media, property and renewable energy.
Christian is a non-executive board member to a number of leisure and hospitality companies, Casper & Cole Ltd, Wright & Bell Ltd, Ruth & Robinson Ltd, Camm & Hooper Ltd and Darwin & Wallace Ltd.