Ian Warwick discusses the issue of capital preservation and explains why investors and advisers should make sure they understand the model beneath any investment.

    I am a firm believer that any business which sets out to stand still will only ever contract.  The best way to retain the status quo is to target growth.  The only way to achieve commercial success is to continually look to grow and develop.  An analogy often used is that of a sailor on the ocean. If a sailor downs sail with the intention of staying where they are they will soon find they have drifted to somewhere they don’t want to be, the only way they can stay where they are is to continually battle the elements proactively.

    It therefore surprises me somewhat when institutions talk about capital preservation as if it is some sort of Holy Grail that investors should strive to achieve and be grateful for.  In the tax-efficient investment space this type of language has become acceptable as advisers and providers have become paranoid about the regulator’s views of such high risk products.  In order to avoid appearing too ‘racey’, providers have talked about capital preservation as the target for their investments.

    I understand why this is the case but I don’t necessarily agree with it.  Even at the lower risk end of the tax-efficient investment space, such as investments in Government subsidised renewable energy projects, it is possible to target growth.  Especially if looking at riskier EIS or Seed EIS investments then growth has to be the target, otherwise losses will only ever follow.

    "Even at the lower risk end of the tax-efficient investment space, such as investments in government-subsidised renewable energy projects, it is possible to target growth."

    In most cases where capital preservation is offered and achieved I would guess that capital growth has actually been achieved but the provider has reaped the rewards rather than the investor.  I would therefore always urge investors and advisers to understand the model beneath the investment and understand who is actually benefiting; is it the investor, who is taking the financial risk, or is it the manager?

    Investors should be aware that investment in smaller unlisted companies carries with it a high degree of inherent risk, regardless of any tax advantages which such an investment might carry and/or regardless of any steps taken to attempt to mitigate that risk.  Therefore, a proposition offering capital preservation cannot promise capital preservation and could still achieve losses so if an investor has a need and appetite for a tax efficient investment why not consider those aiming to provide growth or an appealing annual yield?  I am a firm believer that investors should only invest in tax-efficient investments where the investment is an appealing proposition in itself.  An investment should always be undertaken on its own merit and any potential tax reliefs available should be a bonus rather than the reason for selecting a proposition.  Of course it should also be remembered that tax reliefs are dependent on individual circumstances, cannot be guaranteed and may be subject to change.

    If a provider is offering capital preservation as the primary goal of a tax-efficient investment, particularly if their calculations also show calculations assuming tax reliefs, be wary.  It may be appropriate for your client but take extra care – someone somewhere will be making money but it probably won’t be your investor.

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