Perceiving track record of fund managers is key as EIS popularity grows

While investing in EISs is not without risks, the incentives for investors looking at tax-planning opportunities are considerable, with subsequent government legislation expanding the potential tax reliefs even further.

A recent HMRC report into the use of EISs showed that almost 80 per cent of investors considered income tax relief to be a key driver when considering investment, and the same report suggested that six in 10 companies believed investment in their business was either unlikely or would not have happened without the EIS tax reliefs available to their investors.

 Demand is now starting to outstrip supply and advisers appear to be undertaking much more due diligence when considering EIS-qualifying schemes for their clients

It is of little surprise therefore that the EIS has grown in popularity with small companies, financial advisers and their clients, and the majority of financial advisers are expecting to write more EIS business with their customers in the future.

The FCA and Financial Ombudsman Service consider EIS products to be among the very highest risk of all retail investment products since they involve investing in small companies.

Firms that attract EIS status are by their nature small, and it is widely accepted that small businesses tend to have a higher failure rate than larger companies. This has led to an increase in the popularity of discretionary managed EIS portfolios, allowing investors to diversify and spread their risk across a number of underlying companies.

Coupled with the restrictions imposed on other tax-efficient investments in recent years, EIS-qualifying investments are becoming a more prominent part of many client portfolios.

Nevertheless, two recent changes designed to redirect EIS money have led to a decrease in the number of EIS-qualifying funds offered by fund managers, with some estimating that these changes have removed up to £350m of supply from the market.

Electricity generation from renewable energy sources, particularly solar and wind energy were once extremely popular as income was secured by public subsidies, but electricity generation is now an excluded trade under the EIS rules.

In addition, and in line with EU State Aid regulation, investment managers must now invest in businesses that can demonstrate their potential for growth and development. Such companies are typically smaller deals that are harder to source in comparison to later-stage companies that some managers previously focused on.

Demand is now starting to outstrip supply and advisers appear to be undertaking much more due diligence when considering EIS-qualifying schemes for their clients, as this mismatch in supply and demand may result in some managers raising more money than they can successfully deploy.

Advisers should therefore understand the track record of the managers, not just in driving returns for investors, but also in their ability to deploy funds into businesses within their sector of expertise.

General enterprise, media and technology remain the three most popular sectors for EIS investment. But as the popularity of the scheme continues to increase, the number of sectors that receive EIS money will rise, and understanding the track record of investment managers will be more important than ever.

Adam Spence is a partner at Edition Capital