Enterprise Investment Scheme (EIS) funds, often considered to be useful for the ‘mega-wealthy’, are significantly under-utilised by financial advisers.
The claim comes from Andrew Aldridge, a partner at Deepbridge Capital, who has estimated that just 30% of financial advisers in the UK would consider EIS funds as part of their financial planning.
“With the pension LTA and tapered annual allowances now affecting many more clients than just ‘the wealthy’, there is perhaps now a genuine need to consider other tax-efficient structures for a broader range of clients,” he says.
“With most EIS funds accepting investments as little as £10,000, there are opportunities for advisers to provide investors with tax-free growth away from pensions without having to commit unwieldy amounts – of course, there are myriad other tax reliefs with EIS qualifying investments as well, not least 30% income tax relief, CGT deferral, inheritance tax exemption after just two years and loss relief, in case everything does go wrong.”
Illiquidity spooks investors
The risks of using EIS funds are one of the main barriers for advisers, particularly as they are illiquid.
Independent wealth consultant Adrian Lowcock says: “EIS funds are typically illiquid and you need to hold the investment for at least three years. In addition, performance might be a factor. Because of the early phase nature of the investments, you might not see decent returns for five years or more.
“In a world where advisers are reporting more frequently than that and a need for them to justify an investment, five years is a long time. Many EIS funds also focus on specific sectors – technology being a major one. Many portfolios are likely to have significant exposure to technology and may not need more exposure to the space.”
Aldridge argues, however, that as part of a well-balanced portfolio these funds have a place.
“There could be opportunities to maintain an appropriate portfolio risk profile while including EIS opportunities to create a private equity portfolio. Of course, such a portfolio could also benefit from the downside protections of tax and loss reliefs,” Aldridge says.
“For example, tweaking the balance of a portfolio to include more ‘lower risk’ products, such as bonds, could allow for a small proportion of high-risk EIS stocks, which provide the potential for significant growth while maintaining the overall portfolio risk profile.”
He adds: “EIS isn’t just for the super wealthy and is also not just for the world’s risk-takers. EIS could form part of more investors’ portfolios.”
Proceed with caution
For Rowley Turton chartered financial planner and director Scott Gallacher, the risks of EIS funds are generally incompatible with the firm’s client base.
“As a firm, we are very cautious about using EIS funds, even for very wealthy clients. However, more important than the risk factor, I have struggled to find compelling evidence about the overall performance of EIS funds,” he says. “We know that the average managed fund has made clients money over time, but can we say the same about the average EIS fund?
“I find that advisers and tax specialists recommend EIS funds because of the tax advantages rather than any specific investment reason. A classic case of the tax tail wagging the investment dog.”
He adds: “Some years ago, we took on a new client whose adviser had recommended they invest in many EIS funds and other tax-efficient investments. However, when we crunched the numbers, we found that even with the tax advantages, the client had made a loss, and this was during a period that traditional managed funds had made a healthy profit.”
Due diligence
There are other issues for advisers, too, when it comes to EIS funds. Lowcock explains that the research and due diligence requires more specialist knowledge when selecting an EIS, which is an additional resource.
“This is because the funds are usually very concentrated – maybe a dozen investments – and the investments are made at the early phase of a company’s growth and are therefore higher risk,” he says.
“The issue for advisers is that the losses can be significant as companies could potentially collapse and, while the gains could also be huge, it raises the question, are they worth it? Given many advisers’ primary objective is to protect client capital and then grow it, EIS funds would be harder to support as early-stage investing has its own challenges.”
He adds that with the rise in Isa allowances, there is plenty of scope to shelter money in tax-efficient vehicles outside of EIS funds – pushing them further down the line.
“For these reasons they are usually suited to wealthier clients who can afford the risk and are looking for additional diversification. Smaller investors are increasingly able to access private equity, albeit further along the road, through investment trusts and can achieve similar diversification that way,” Lowcock explains.
Difficult years
EIS have had a rollercoaster few years, starting with the government’s Patient Capital Review in 2017 and the removal of asset-backed companies from the qualifying criteria.
In the following two years, inflows into EIS funds plunged. This was further exacerbated by the coronavirus pandemic that caused a 30% year-on-year fall in investments into EIS between 2019 and 2020, according to data from EISA.
Confidence is, however, starting to return – among product providers at least. Towards the end of last year, Octopus Investments, which abandoned fundraising the EIS market in 2016 in favour of venture capital trusts, re-entered the market with the launch of its Ventures EIS.
Commenting at the time of the launch, Octopus managing director Paul Latham said: “UK early-stage companies will play a critical role in driving the post-Covid economic recovery and Ventures EIS provides equity financing to them when it’s most needed, while also offering investors attractive growth potential and tax benefits.”
