Please note that tax, investment, pension and ISA rules can change and the information and any views contained in this article may now be inaccurate.
How to invest in Boris and Rishi’s ‘big bang’
The prime minister and the chancellor have written an open letter to the UK’s institutional investors, challenging them to ignite an ‘investment big bang’ by investing in illiquid assets, such as infrastructure and unquoted companies.
The chancellor is also setting the groundwork for the launch of ‘Long Term Asset Funds’ later this year, which will be open-ended funds that invest in illiquid assets.
There are reasons why private investors might want to invest in illiquid assets, and ways they can already do so, but there are also significant risks to be considered when investing in this area.
APPEAL OF SMALLER COMPANIES
One of the illiquid assets into which the Government is trying to encourage money is small companies that aren’t listed on the stock exchange.
Investors can potentially benefit by tapping into the high levels of growth these companies can experience before they float on public markets. There are risks as smaller, entrepreneurial businesses stand a much higher chance of failure than the big blue chips traded on the stock market.
Another illiquid asset class the PM and chancellor are trying to promote is infrastructure. Investors tend to choose this sector because of the income streams on offer, which are often linked to inflation.
At the moment, many of the emerging infrastructure opportunities are in green infrastructure, which fits the bill for investors who want an ESG tilt to their portfolio. It’s also why the PM and Chancellor want to promote the benefits of investing in this area, as it helps to pay for the Government’s green agenda.
HOW TO ACCESS ILLIQUID ASSETS
One of the problems with illiquid assets is how to gain access to them. Open-ended funds offer investors daily dealing so aren’t best placed to invest in illiquid assets, which take a long time to sell.
For example, someone might have money in an open-ended fund that invests in various big office blocks. If they decide to withdraw their money, the fund manager must immediately find cash to pay them back. If there isn’t enough available cash, they would have to sell some assets and finding a buyer for an office block is not straightforward and certainly cannot be done in a day or even a month.
However, investment trusts can offer investors access to these hard-to-reach areas of investment markets, because their closed-ended structure means they don’t have to sell underlying investments to meet investor withdrawals.
When an investor wants to get out of a closed-ended investment trust, they simply sell their shares on the market to another investor. The fund manager doesn’t have to do anything.
The cost of that liquidity is reflected in the premium or discount the investment trust is trading at, which adds to the volatility of the investment.
RANGE OF INVESTMENT TRUSTS
There are plenty of investment trusts which offer exposure to illiquid assets, though they may not all be as UK focused as the PM and Chancellor might like.
Investors are probably more concerned with creating a diversified portfolio of good investment opportunities rather than using their money to do a bit of flag waving.
Pantheon International (PIN), for example, is an investment trust which invests in a global portfolio of private equity assets, while 3i Group (III) offers exposure to private equity and infrastructure opportunities in Europe and North America.
If it’s specifically green infrastructure you’re after, there is the renewable energy infrastructure sector to consider, containing trusts such as Greencoat UK Wind (UKW) and The Renewables Infrastructure Group (TRIG).
Investors need to be wary of hefty premiums on infrastructure trusts, which have been driven up by the low interest rate environment.
To access some privately-owned companies in a more diversified growth trust, investors could look at Scottish Mortgage Investment Trust (SMT), which has around 20% of its portfolio invested in unlisted equities.
Investors can also invest in small unquoted companies through venture capital trusts or enterprise investment schemes, respectively known as VCTs and EIS. These tax wrappers offer investors exposure to small, unquoted companies with considerable tax breaks to boot.
VCTs offer investors up to 30% tax relief on their initial investment, with tax-free dividends and growth. To keep the tax relief, you must hold the VCT for at least five years.
EIS products also offer 30% upfront tax relief, with tax-free growth. There is also the potential to defer any previous capital gains from other assets by holding that money in an EIS product.
The tax benefits of these schemes are clearly very attractive, but the investments are very high risk and so only for investors with a high tolerance for risk and loss.
This really goes for illiquid assets more generally, and even for adventurous investors they should only make up a small part of a diversified portfolio.