Due diligence on alternative assets

    Due diligence on alternative assets

    Examples of alternative assets include venture capital trusts (VCTs), enterprise investment schemes (EISs) and fine wines.

    These alternative assets are probably better defined as tax shelters as both VCTs and EISs can be used as tax efficient investments in appropriate circumstances.

    Before we get started there are a few principles that are consistent for all regulated independent financial advisers and it is these principles we will use as a benchmark.

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    1) The FCA ‘Standard for Independent Advice’ states that personal recommendations should be: based on a comprehensive and fair analysis of the relevant market; and unbiased and unrestricted.

    2) Don’t take what the providers tell you as being all the facts you need to gather as part of your due diligence – facts often need to be probed and verified.

    3) Treating Customers Fairly – treating customers fairly should form part of the process.

    In other words, the research and due diligence undertaken is critically important because failing to meet the FCA standards means not only are the recommendations questionable and perhaps unjustifiable, but the status of independent advice is also at risk.

    The Retail Distribution Review also highlighted to restricted advisers that they need to know enough about a market they would not normally advise upon to ensure they are in a position to judge whether their solution is suitable or if they should refer to another adviser.

    The main objective in undertaking due diligence is to make sure the solution represents good value to the client and meets their specific needs.

    Holistic Financial Planning

    Using alternative assets or tax shelters is only likely to be suitable for those investors who already hold a portfolio of more conventional ‘retail’ investments.

    Within this portfolio one would expect to see that the client’s tax efficient allowances have been thoroughly utilised, for example pensions and Isas.

    An example might be the high earner who previously saved in a pension but because of the reduced annual allowance is looking for alternative tax efficient investment vehicles.

    Alternative assets are commonly deemed to be more risky as the underlying investment tends to be into small, new and/or early stage companies.

    Compared to established businesses these companies tend to experience more financial challenges and/or have their profitability affected by just one individual’s performance.

    Secondary trading markets are not as usual, sometimes non-existent for alternative assets. 

    They also tend to be more illiquid and gaining access to any return, without significant costs, in the first few years can sometimes be difficult.

    While the tax efficiency can be very attractive and indeed indicate good returns are possible it is important to evidence that the underlying assets are actually performing and the investment manager is not relying on tax efficiency for creating returns.

    That being said, it is not unusual for propositions at the less risky end of the market to forecast only low single digit returns.