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We Ask Questions of Buy and Hold Strategies

Many investors over the past 12-24 months, with the benefit of hindsight, may have found themselves wishing they had crystallised some gains before the market correction affected high flying, more interest rate sensitive sectors such as technology. It has also renewed the debate as to whether an actively managed investment portfolio can be physically maintained alongside legacy buy and hold strategies.

Most investors enjoy watching the stocks they own, develop, and grow in value over time, but at what point does that growth become a hindrance to the diversification, safety and opportunities within the rest of your portfolio?

Buy-on-dips or buy-and-hold strategies have been a key strategy since the Global Financial Crisis (GFC) particular as the volume of passive investment strategies has grown, and Quantitative Easing (QE) turned asset markets into a one-way bet, however, the point of entry matters over time. Absolute Strategy Research (ASR), the Independent Macro-Strategy Research Provider to Hottinger, point out that strong equity returns in the medium to long term tend to rely on a sound starting valuation. We believe it will be very challenging to attempt to trigger a new bull market equity rally with stock market indices priced at around 20 times price-to-earnings valuations, and it can often take a long time to recover from a significant drawdown following peak valuations: examples would be 29 years after the 1929 crash and 15 years following the 2000 tech market bubble. We would argue that the rally seen in cyclical stocks since the start of the year smacks of investors looking to re-invest after the 2022 drawdown, especially in technology stocks, without giving due consideration to the entry point. Indeed, ASR point out that the correlation between cyclical stocks and the ISM New Orders Index has broken down as the New Year rally pushes ahead of fundamental economic data.

A buy-and-hold strategy since the GFC will have amassed some significant gains in some now mega-cap companies, and the maintenance of such a portfolio requires the trimming of positions in order to maintain the integrity and diversification of the portfolio as a whole. Running a portfolio with many out-sized positions could lead to unintended consequences on the upside through sector rotation and the downside when certain sectors re-value as with technology in 2022. As a discretionary investment manager, we would consider investment decisions to be the main consideration when constructing and maintaining an investment portfolio and any decisions surrounding taxation to be secondary. We believe allowing taxation to dominate investment decisions will lead to questionable decision-making and a less efficient deployment of capital.

In the UK, many investors have made good use of the capital gains tax annual allowance to trim positions thereby reducing the tax liability created through the crystallisation of gains. Afterall the decision to pay capital gains tax (CGT) could be considered voluntary because the decision to crystallise a gain is voluntary. However, we would argue that having made the decision to create an investment portfolio, and perhaps seek professional advice,  the investor has decided that they wish to employ a strategy that promotes investment decision-making. The 2022/23 CGT individual allowance is £12,500 and the government has announced plans to halve the capital gains tax to £6,000 this year, and again to £3,000 in 2024. This will increase the difficulty of using the allowance to maintain an efficient, balanced portfolio meaning many investors may find themselves with larger CGT liabilities going forward.

While we do not provide tax advice and do not run investment management strategies based primarily on tax efficiency, there are certain options investors may wish to consider in coming months as the deadline for CGT allowance cuts approaches and we would advocate seeking professional advice where appropriate. We also appreciate that current UK government policy is open to any policy change or amendment proposed by any future administration.

Currently, a lifetime buy-and-hold strategy will see all unrealised gains nullified on death by the prospect of pending inheritance tax considerations, however, such a strategy for those with the prospect of many years of investing ahead of them could suffer from many of the disadvantages already discussed. A CGT allowance is a ‘use it or lose it’ type of tax system, meaning unused allowances cannot be carried into the next year. Considering the allowance halving this year, then halving again the next, it could well be worth thinking about making the most of the current £12,300 individual allowance if not already done so.

Historically, many investors tend to opt for living off the income derived from capital thereby paying income tax on dividends at their personal rate rather than paying CGT. However, it may be useful to note that CGT rates are dependable on an investors income band, and it can, in some cases, be more tax efficient to take a CGT gain rather than potentially raising their income tax band, which also has a knock-on effect to CGT rate. If a spouse has a different tax band an investor may wish to seek advice about transferring assets without creating a tax event.

There are a number of tax wrappers that allow an investor to build an investment strategy without tax considerations namely ISA’s, investment bonds, and Self Invested Pension Plans (SIPPS). Indeed SIPPs also have the benefit of all contributions being gross of income tax. Furthermore, the use of open-ended investment funds also allows the fund manager to manage the portfolio and the tax considerations within while the end investor only deals with such considerations at disposal.

Alternatively, if an investor does not wish to manage out-sized gains within a portfolio, there may be an option available to ring-fence such positions more efficiently in an execution-only account and allow their managed investment strategy to continue without the incumbent distractions. However, this does not stop such investments from impacting on the overall estate of the investor so absolute confidence in the decision to make lifetime hold decisions for tax reasons should be taken with due consideration under professional advice.

In a world where economic and investment cycles seem to be shortening giving rise to short term periods of extreme volatility it may pay to be nimble, agile, and responsive to both threats and opportunities in these challenging times by focusing on key investment management decision-making. As the CGT allowance falls to £3,000 from April 2024 onwards celebrating profits on good investments net of tax considerations and maintaining a suitable investment strategy that allows for appropriate decision-making could be key to maximising future returns.

Our investment strategy committee, which consists of seasoned strategists and investment managers, meets regularly to review asset allocation, geographical spread, sector preferences and key global market drivers and our economist produces research and views on global economies which complement this process.

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