The term 'capital preservation' is often banded around within tax-efficient investment circles, but often with differing meanings. This can therefore often lead to confusion for advisers and investors alike.
As far as I am concerned there are effectively three ways in which the term capital preservation can be interpreted, or has been misappropriated, and I believe it is important that financial advisers and investors understand which of these is being used when considering such propositions.
1) Capital preservation: a verb
The objective of such investments is to invest in propositions that benefit from predictable revenue streams and are possibly asset-backed. Such propositions are long-term investment opportunities that are uncorrelated to market volatility. The underlying companies are trading businesses and therefore qualify for business relief (formerly business property relief) and are potentially a useful inheritance tax planning tool. Such propositions may produce healthy returns for investors but will always have an underlying business model which is predictable and have an ongoing resale value.
2) Capital preservation: a noun
Thankfully such propositions are no longer as common as they once were. Such propositions, historically often utilising Enterprise Investment Scheme reliefs, would offer a relatively low return to the investor with the illusion that the investment was in some way lower risk than other propositions. An investor's desire to preserve their capital would be an excuse to only return marginal gains with some investment managers historically charging a 'performance' fee on any returned monies over 95% of the investment. Yes, that's correct; they would charge a performance fee having lost the investor money! The argument being that the potential tax reliefs available to the subscriber were the real reward. In some cases it may also have been that investments performed well but the investment manager reaped the financial reward and only passed on the advertised low return to the investor.
3) Capital preservation: a question.
With energy focused propositions no longer qualifying for EIS tax reliefs, investment managers have been searching for that next proposition which offers to preserve an investor's capital while still qualifying for the potentially generous tax reliefs available via EIS. Such propositions often focus on companies for which using property is an important part, if not the focal trade, of the business. These may include care homes or storage. The question to be asked here is whether those 'assets' have a tangible value if not being used for the trade of the business, e.g. if a storage company went in to administration, would the prefabricated building-shell be worth much that could be distributed to shareholders? Over recent years we have seen tightening of EIS qualifying criteria in order to ensure the investors benefiting from EIS tax reliefs are doing so for the greater good of the economy. To this end, is there a chance that an investment which is not creating jobs or supporting innovation could be reviewed by HMRC?
Advisers and investors should carefully consider the various definitions of 'capital preservation' when reviewing any tax-efficient investment. As efforts have been made to homogenise the tax-efficient investment space it has become popular to label products and attempt to apply a one-size-fits-all approach to what is essentially a very diverse investment sector.
The Capital Preservation label is somehow seen as a low-risk investment and also sets an expectation of low returns. This is not the case. Any investment in unquoted stocks (including stocks classed as unquoted, such as AIM) should be regarded as high risk and illiquid (any liquidity offered by investment providers should be considered on a case by case basis). Countering that, because a investment seeks to first and foremost preserve capital that doesn't necessarily mean decent growth or income cannot also be produced.
The best way to understand the risks, the opportunities and the way in which capital is preserved is to understand the underlying investments. I would suggest that if investing via EIS then really investors should support the 'spirit of EIS' and invest in companies that seek to create jobs or support innovation. This approach will lead to little HMRC challenge and offer potential investment reward for what should always be considered a high risk investment (I'm sure your compliance team will agree!).
If looking at a capital preservation strategy for the benefit of IHT planning, via business relief, then my advice is no different and I'd suggest advisers and investors should again seek to understand the underlying assets and business models. Don't be afraid of decent returns if the underlying model is correct. With any investment it is the investor that is taking the risk so they should be the ones benefiting the most from any returns.
Before assuming a proposition is right for an investor simply because it declares itself to be capital preservation focused, consider their definition and what the really means.