What are the squirrels ?? crossing the road in the tax-advantaged market?

This was the theme for a rather different presentation I gave recently for an Autumn roadshow to several rooms full of financial advisers up and down the country.

As anyone that has seen me speak recently can confirm, my openers are deliberately somewhat left of field. (Now you're listening I will go on).

To give this daring rodent tale some context we need to delve back into the world of Consumer Duty (please stick with me), in particular one of the FCA's three cross-cutting rules:

• Avoid causing foreseeable harm to retail customers [either through act or omission]

No issue with this, I believe we're all agreed this is a good thing once we understand and can put foreseeable harm in context.

“The FCA intends on using foreseeable harm to enforce Consumer Duty rules and force firms to become more client centric”

Again, a client-centric approach is understandable, desirable and expected. They continue with:

"Whether or not harm is foreseeable is based on the concept of a prudent firm which, when acting reasonably, would be able to predict or expect the ultimately harmful result of its action or omission”

For me, they lost the crowd with this one.

Personally and for me at least it needs some real world context - probably because I'm a rather simple mind.

Enter the squirrel, courtesy of Chat GPT. ??

I put this paragraph into Chat GPT, explained the context (as Chat GPT works best with some context) and asked for a real world example. Here we have it:

Imagine you're driving a car on a rainy day. You're following the car in front of you at a safe distance, and suddenly, that car slams on its brakes to avoid hitting a squirrel that darted into the road. You also hit your brakes but end up rear-ending the car in front of you.

In this scenario:

Foreseeability: Whether the harm (the car accident) was foreseeable depends on your actions as a driver. If you were driving attentively and at a safe speed, you might reasonably expect that unexpected events, like an animal crossing the road, could occur. So, it was foreseeable that such an event could lead to a car accident.

So bringing this off the road and into the world of investment advice.

Harm is foreseeable when making or recommending investments. Investments and investment sectors can perform poorly (with or without fees), and some may even fail - as can their managers.

So what are the “squirrels crossing the road” that you can reasonably expect in the tax-advantaged market?

Ok it's a rather tenous link, but getting squirrels into a presentation about Consumer Duty deserves some kudos surely...? This is financial services, we have to do something to liven things up.

So what are they?

Not exhaustive, but here are SIX that I shared with advisers and think are worth considering in the context of avoiding foreseeable harm:

1. Manager Failure
2. Tax-relief not being being granted
3. Poor performance
4. Over-concentration
5. Liquidity Issues
6. Hidden fees

Hopefully you've got this far, and if you have - that in itself suggests a level of prudence and at least a desire to better understand foreseeable harm in the context of tax-advantaged investments .

If you're still with me, you might be thinking when looking at this list - Where do I start? or Why should I bother?

The good news, is that its now a lot easier than it used to be and a lot more efficient than you might think. Why? Because the clever people over at MICAP score each EIS, VCT and Business Relief qualifying investment across these areas - so you can easily compare and benchmark them.

Hidden fees

The last one (Hidden fees) is covered by the latest and ninth score to come out of the MICAP stable - last week they launched their new Fees and Charges score.

A score designed very much with Consumer Duty in mind, particulary the 2nd of the FCA's outcomes - Price and Value.

Mark O'Donnell, Head of Research at MICAP had this to say:

"Assessing fees in the tax-advantaged market is notoriously difficult for a number of reasons, not least because investment managers are not obliged to publish the fees they charge to investee companies,"

"We are immensely proud of our new fees and charges scores which we hope will bring increased transparency to the sector, and allow advisers to demonstrate their compliance with Consumer Duty with just a few clicks of their mouse."?

This really is a very important area for advisers.

It's an area where they can really add demonstrable value, avoiding foreseeable harm in the context of fees and charges their clients will incur both at the point of investment and during the lifetime of the investment.

The holding periods have evolved in recent years too, as have deployment timeframes for some EIS.

So understanding price and value over what could be a 10 year holding period is necessary. The new fees and charges score helps with this, as does the full breakdown of all the fees - which MICAP has for each investment on its fund-finder and comparison tool.

The team at MICAP have done a lot of the heavy-lifting for advisers and paraplanners, making it easier to compare managers and their investments across nine key areas:

1. The manager
2. Track record of the fund (NEW FOR 2023)
3. The level of diversification
4. The stage of companies targeted
5. The exit strategy
6. Liquidity
7. The manager’s HMRC procedures
8. The fund’s regulatory status
9. Fees & Charges (VERY NEW)

Final thoughts - cost and simplifying

Hopefully this article gives some useful context to anyone researching or recommending tax-advantaged investments as we head into the business end of the tax season.

There is obviously a 'cost' to you the adviser and your firm of this additional work, and the knowledge required and so I encourage advisers to charge appropriately for the time/cost involved. That's easy for me to say, and perhaps I am biased so I give you this from Dr. Matthew Connell from the PFS:

You've got to think about the commercial costs of providing additional value. That might be the enhanced due diligence requirements, the additional work needed to ensure a high-risk investment is suitable, or the time needed to maintain specialist knowledge

One final thought, and something that didn't come from Chat GPT and is very much my own two pennies worth. I have tried to simplify what the FCA is asking for in the context of foreseeable hard, picking out (and in bold for ease) some of the points from their papers, statements and guidance.

So for what its worth here it is, (not intended as guidance/advice etc as I am not qualified to give any, so just an interpretation):

A client-centric and prudent firm that acts reasonably, by conducting appropriate due diligence on investments and charges reasonable fees when compared with the benefits of the recommended products and service received.

This works for my simple mind, and hopefully it makes a bit more sense to you.

Look out for those squirrels !

If in doubt head over to MICAP for help spotting them.

No rodents were harmed in the writing of this article. (my kids love squirrels, rodents feels like a disservice)