This article is written by:

Simon Evan-Cook

Fund Manager, MGTS Downing Fox Funds

How fund of funds are well suited to the lower personal Capital Gains Tax (CGT) free allowance

Advisers fell out of love with funds of funds, largely on account of charges. But with the MGTS Downing Fox Funds having addressed that with our unique ‘whisky and water’ charging structure, they’re back on the dating scene.

And not a moment too soon. With personal capital gains tax allowances slashed, you’re having to pay more attention than ever to avoid triggering unexpected tax bills for your clients.

This is more likely to happen if your clients are invested in Model Portfolio Services (MPS) or Discretionary Fund Management services (DFMs).

Here’s why:

• DFM and MPS are typically open portfolios.  By ’open’, we mean your clients hold the funds or securities directly, not wrapped up within a single fund. This means each time a holding is sold – perhaps it’s being swapped out, or maybe it’s part of an asset allocation tweak – it is a potentially chargeable CGT event (naturally when held outside of a tax wrapper).
• The larger your client’s invested wealth, the more likely it is that changes made over a year will trigger a CGT charge. So this is an issue that may impact your most valuable clients.

How are fund of funds different?

In contrast, within a fund of funds, changes made to a portfolio are immune to CGT.

This puts control back in your hands, and not those of a distant portfolio manager who doesn’t know your client. Which means that investing your clients in a fund of funds, and not an MPS or DFM, significantly reduces the risk of triggering an unnecessary CGT bill for your clients.

Looking beyond tax

The implications of this difference in tax status go beyond just tax. It can have a knock-on impact on how the portfolios are managed and, therefore, the returns they generate.

• Portfolio managers of “open” portfolios know their decisions may trigger CGT charges for some of their investors. This affects their decision making. If they believe a fund they hold is past its best; maybe because the manager has left; or it’s become dangerously large, they will be more reluctant to sell it because of the tax implications.
• This is bad news for existing clients, as they’re now more likely to be exposed to investments that are past their best-before date.
• It’s potentially even worse for new clients being invested into the same centralised model portfolio: they are effectively being invested into sub-optimal funds because of a complete stranger’s tax considerations.

None of this applies to managers of funds of funds. As their decisions have no CGT implications, they’re free to pick the best investments at any given time. The common response from MPS and DFM managers is that their activity helps to manage CGT liabilities by using up tax-free allowances over the course of a tax year.

For clients of a very particular level of wealth, this may be true. But with the CGT allowance coming down, the number of clients who will be hurt by this, rather than benefitting from it, will increase. Furthermore, the design of the MGTS Downing Fox Funds range means you can easily replicate this benefit, while also fine tuning your clients’ risk profiles as they walk life’s financial path. For many clients, this will be a big ‘value add’ service from their adviser.

The MGTS Downing Fox Funds Range

The MGTS Downing Fox Funds range consists of four funds. They hold identical investments to each other, just in varying proportions to suit different risk profiles. This means:

• If your client is invested in the 60% equity fund, you can switch all, or part, of their holding into a 50/50 mix of the 80% equity fund and the 40% equity fund. This will not only trigger the desired CGT gain/loss but will also maintain the same underlying holdings and exposures with no time out of the market.
• At the same time, you also have the flexibility to raise or lower their risk-reward exposure. So, for a client who’s approaching retirement, you could tweak down their equity exposure, while also reducing their future CGT liability.

Cleaner tax management is just one of the advantages that funds of funds, and particularly the MGTS Downing Fox Funds, have over competing products.

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Important notice

This content is intended for financial advisers and has been approved and issued as a financial promotion under section 21 of the Financial Services and Markets Act 2000 by Downing LLP. Any subscription to the fund should be made on the basis of the relevant product literature available from Downing, or from the ACD, Margetts Fund Management Ltd and your attention is drawn to the charges and risk factors contained therein. Any personal opinions expressed are subject to change and should not be interpreted as advice or a recommendation. Capital is at risk and investors should note that their investments and the income derived from them can fall as well as rise and investors may not get back the full amount invested.