Why a co-ordinated strategy works
Wrap accounts are clearly gaining in popularity. The idea is that a client has a single co-ordinated investment portfolio employing a strategy across a variety of investment ‘pots’ or sub-accounts. These accounts might be allocated for specific purposes such as short to medium term funds, a longer term portfolio and a pension. More likely, they are divided up into different investment ‘wrappers’ that afford a variety of tax breaks.
Tax breaks
In the UK individuals take advantage of their annual individual savings account (ISA) allowance which allows tax free income and capital returns on investments, as well as their annual capital gains tax exemption allowing a limited amount of profits to be realised tax-free. Additionally, assets held within a pension scheme attract tax breaks.
Wrap accounts make sense in these circumstances, because assets can be managed as a whole, rather than as a series of separate portfolios, where an individual will be more likely to experience duplication (both of assets and dealing costs) rather than true diversification. But there does not have to be a formal ‘wrap programme’ to achieve this – it is simply the creation of a co-ordinated investment strategy by a wealth manager that seeks to direct different asset classes to the most appropriate holding vehicle.
Single portfolio
Many wrap strategies create a single portfolio to reflect an individual’s investment objectives, e.g. income versus growth, together with their appetite for investment risk. This is allocated on a pro-rata basis across their different sub-accounts to use up the valuable tax breaks.
It should be possible to enhance this strategy further by considering the tax treatment of each individual asset class within the specific sub-account. In the UK, it is no longer possible for pension schemes to reclaim withholding tax on dividends. Therefore, the ‘tax free’ status of this vehicle is impaired if it is heavily invested in high yielding UK equities. From a pure tax perspective, it would be advantageous to allocate, where possible, the bond portion of the portfolio to the pension pot, thereby making full use of its tax breaks.
Hedge funds are often best held in an offshore insurance wrapper, while private equity investments are best held directly, as this allows investors to take advantage of the accelerated reduction in capital gains tax.
Every wealth manager strives to increase investment returns without increasing the risk, and adding this planning to the overall strategy helps to realise this aim.
Christine Ross is head of financial planning at SG Hambros
