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Fund switches to crystallise a loss

Market falls may provide opportunities to rebalance your portfolio in a tax efficient way
September 24, 2015

Earlier this month we wrote about using market falls to cut your capital gains tax (CGT) bill. The strategy involves disposing of investments held outside individual savings accounts (Isas) and self invested personal pensions (Sipps) at a loss, and offsetting this against gains in the future as you can carry losses forward indefinitely.

A problem with this strategy is that you cannot utilise the loss if you then reinvest in the same asset within 30 days of the sale unless you are buying it back from within a tax advantaged wrapper such as an Isa or Sipp. If you have used up your annual Isa and pension allowances, or your pension lifetime allowance of £1.25m, an option could be to reinvest in an alternative asset.

There are a number of pros and cons with this strategy but if it does suit your circumstances we have set out some potential fund switches to consider.

 

Templeton Emerging Markets to Genesis Emerging Markets

Templeton Emerging Markets Investment Trust (TEM) historically had a strong performance record but has lagged behind the MSCI Emerging Markets Index for the past five of its financial years, and also underperformed this and its sector average over one, three and five years cumulatively. Over the trust's last financial year investments in materials, energy and financials were detrimental to performance, while it also puts the underperformance down to its value and contrarian approach.

Meanwhile Templeton Emerging Markets' long standing manager Mark Mobius is standing down from 1 October.

All these factors led us to drop Templeton Emerging Markets from the IC Top 100 Funds earlier this month.

"Templeton Emerging Markets has recently made changes to the management team as part of some overdue succession planning," says Ewan Lovett-Turner, director at Numis Securities. "However, recent performance has been disappointing and we were unimpressed at a recent analyst meeting which provided no convincing explanation for the degree of underperformance. Despite a strong long-term performance record, the jury is still out in relation to Templeton's future. It may be worth considering Genesis Emerging Markets Fund (GSS) as an alternative: this fund is also managed through a bottom-up, value oriented approach and benefits from an experienced management team."

Both trusts trade at a discount to NAV of around 11 per cent. Genesis' discount is wider than its 12-month average of 9 per cent. It outperforms Templeton over one, three and five years, albeit with negative returns, and its share price is behind MSCI Emerging Markets Index over these periods though the NAV returns are better.

It also has a higher ongoing charge than Templeton - 1.45 per cent as opposed to 1.22 per cent.

Genesis has 164 holdings against around 50 for Templeton. Genesis' managers believe long-term investment returns in emerging markets equities are delivered by identifying underpriced companies to create a diversified portfolio. They invest with a five year time horizon in mind.

They aim to identify companies best able to take advantage of emerging market growth opportunities and which trade at an attractive discount to their assessed intrinsic value. Genesis' portfolio has three components: growth, value and companies that display characteristics of each style.

Trust1-year share price return (%)  3-year cumulative share price return (%)5-year cumulative share price return (%)10-year cumulative share price return (%)Discount to NAV (%)Ongoing charge (%)
Templeton Emerging Markets Inv Trust Ord-29.0 -23.0 -24.9 106.8 11.1 1.22
Genesis Emerging Markets Fund-21.5 -15.0 -10.3 110.5 11.5 1.45
MSCI EM NR GBP-16.1 -7.9 -9.0 90.5
AIC Global Emerging Markets sector average-17.0 -8.3 0.8 60.0

Source: Morningstar, as at 17 September 2015

 

Developed markets to developed markets

It's probably a good time to tilt away from markets where valuations look stretched or the outlook is poor, and recycle your investments into better opportunities, says Jason Hollands, managing director at Tilney Bestinvest. "In the current environment where central bank policies look set to diverge between those expected to tighten and those whose feet are still hard on the accelerator of stimulus, I'd be tilting away from markets like the US which has enjoyed a valuation premium towards the eurozone and Japan," he says.

If you are in a poorly performing US fund then this could be a good moment to reallocate some of your money. Many active large-cap US funds have failed to beat their benchmarks and Tilney Bestinvest highlights some poor performers in its Spot The Dog Report on under performing funds. These include Miton American (GB00B24CSS91), Legg Mason IF Clearbridge US Equity Income (GB00B3NQ7J33), Baillie Gifford American (GB0006061963) and Cavendish North American (GB00B60SMG56). However, US markets have boomed in recent years and even underperformers have made money for investors, so you will need to check you have made a loss on your initial investment to pursue this strategy.

Fund1-year total return (%)3-year cumulative total return (%)5-year cumulative total return (%)Ongoing charge (%)
Miton American I4.934.371.01.11
Legg Mason IF CB USEq Inc X Inc0.433.5na0.91
Baillie Gifford American B Acc14.746.891.50.67
Cavendish North American Fund B4.338.354.80.82
S&P 500 TR GBP6.752.197.9
IA North America sector average6.047.081.2

Source: Morningstar as at 17 September 2015

 

Mr Hollands' recommendation for a new home for your money is Henderson European Focus (GB00B54J0L85) which we recently added to the IC Top 100 Funds and tipped in last week's issue. This fund screens for attractively valued stocks, and then looks for a catalyst that will drive growth and a re-rating of the stock. It has a successful track record of doing this and is among the top 10 performing Investment Association (IA) Europe ex UK sector funds over five years, and is in the top quartile over three. It also beat the FTSE World Europe ex UK Index over one, three and five years.

1-year total return (%)3-year cumulative total return (%)5-year cumulative total return (%)10-year cumulative total return (%)Ongoing charge (%)
Henderson European Focus I Acc4.3 50.3 82.7 97.3 0.86%
IA Europe Excluding UK sector average3.3 36.3 45.3 88.3
FTSE World Europe Ex UK Index TR GBP-0.5 32.9 40.0 88.0

Source: Morningstar as at 17 September 2015

 

US active to US smart beta

While the US may not be looking cheap and active managers may have not performed well, it is still important to retain some exposure to this major market. "If you are crystallising a US equity fund to realise a gain, then consider reinvesting in a fund with a bias towards value rather than the S&P 500 Index," says Mr Hollands. "Options include PowerShares FTSE RAFI 1000 ETF (PSRF), a passive fund which reweighs the 1000 largest US stocks on a basket of fundamental attributes rather than market cap."

This exchange traded fund (ETF) tracks an index which selects its holdings based on four fundamental measures of firm size: book value, cash flow, sales and dividends. The 1000 equities with the highest fundamental strength are weighted by their fundamental scores.

The ETF has an ongoing charge of 0.39 per cent and uses physical replication of the index, meaning it holds the shares of companies in the index it tracks.

1-year total return (%)3-year cumulative total return (%)5-year cumulative total return (%)Ongoing charge (%)
PowerShares FTSE RAFI US 1000 ETF1.044.374.90.39
S&P 500 TR GBP6.752.197.9

Source: Morningstar as at 17 September 2015

Edinburgh Dragon and Aberdeen New Dawn

Aberdeen's Asian funds have historically performed strongly but more recently investment trusts such as Aberdeen New Dawn (ABD) and IC Top 100 Fund Edinburgh Dragon (EFM) have not done so well. But because of the strong reputation of this manager and the long-term arguments for investing in Asia these are funds you may not want to fully abandon. So Nick Sketch, senior investment director at Investec Wealth & Investment, suggests swapping one fund for the other if you want to crystallise a loss.

"Fans of Aberdeen's Asia funds may be able to take a loss if they bought Aberdeen New Dawn or Edinburgh Dragon in the last year," he says. "Either way, if you want to stay with Aberdeen but to trade for tax reasons, then switching between those two looks sensible. These two trusts are not clones of each other but they are similar enough for the trade to make sense if the tax reasons for doing it are compelling."

Aberdeen team manages its funds along the same investment approach, although senior investment manager Adrian Lim takes a leading role in managing Edinburgh Dragon.

The trusts' asset allocations are similar but Aberdeen New Dawn has about 11 per cent of its assets in Australia, while it is Edinburgh Dragon's policy not to invest in this country. The trusts also have top 10 holdings in common.

Edinburgh Dragon has 61 holdings and Aberdeen New Dawn has 52.

Edinburgh Dragon has better three- and five-year performance numbers and is a larger fund with assets under management of £570m against £235m for Aberdeen New Dawn.

Aberdeen New Dawn has an ongoing charge of 1.09 per cent and Edinburgh Dragon has one of 1.19 per cent. They are both on a discount to NAV of around 12 per cent.

But before you sell make sure you have made a loss: even with recent falls you may be able to bank a big gain if you bought one of these trusts a decade ago.

Trust1-year share price return (%)  3-year cumulative share price return (%)5-year cumulative share price return (%)10-year cumulative share price return (%)Discount to NAV (%)Ongoing charge (%)
Aberdeen New Dawn Ord-16.8 -5.7 -3.5 111.5 12.3 1.09
Edinburgh Dragon Ord-17.3 -4.0 3.5 141.4 12.1 1.19
AIC Asia Pacific - Excluding Japan sector average-10.4 -0.9 -10.6 100.0
MSCI AC Asia Ex Japan NR USD-8.4 8.9 9.8 128.9

Source: Morningstar as at 17 September 2015

 

BlackRock to BlackRock

BlackRock World Mining Trust (BRWM) had a strong performance record but has not done so well recently because commodities are out of favour, and over the past year it has had to write down the value of some royalty investments. We have also recently dropped it from the IC Top 100 Funds.

However, its manager, Evy Hambro, and the commodities team at BlackRock are well regarded so analysts are divided on whether to switch out of this trust or not. The trust could also do well when commodities turn.

But if you hold this trust at a loss to what you bought it at you could sell it and reinvest in BlackRock Gold and General Fund (GB00B5ZNJ896), which is also run by Evy Hambro and does not have exposure to royalty investments. The difference is that this fund offers virtually no yield in contrast to BlackRock World Mining's 9.5 per cent. And nearly three-quarters of its assets are in companies that derive a significant proportion of their income from gold mining, in contrast to the widely diversified sector exposure BlackRock World Mining Trust offers.

BlackRock runs a more diversified offshore open-ended fund - BlackRock World Mining (LU0827889725) - which is available on platforms such as Hargreaves Lansdown for an ongoing charge of 1.32 per cent. "It doesn't boost income by writing options or owning royalties but is otherwise a very similar beast," says Nick Sketch, senior investment director at Investec Wealth & Investment.

BlackRock Gold & General can be picked up on platforms for an ongoing charge of 1.17 per cent, while BlackRock World Mining Trust has an ongoing charge of 1.4 per cent.

If there was an upturn in the commodity sector, an open-ended fund would not benefit from a potential re-rating in share price and discount, although investors will not suffer share price volatility with a fund of this kind. Mr Sketch says on that basis you could sell another commodity investment at a loss, for example a direct holding in mining shares, and buy into BlackRock World Mining Trust. It is on a discount to NAV of around 9 per cent.

"Of course, this investment trust is not the same investment as the open-ended funds and this illustrates the danger of these trades if driven by tax," adds Mr Sketch.

Fund/trust1-year total return (%)3-year cumulative total return (%)5-year cumulative total return (%)10-year cumulative total return (%)Yield (%)Ongoing charge (%)
BlackRock World Mining Trust share price-48.9-56.4-56.1-3.79.51.4
BlackRock Gold and General D Acc-30.6-62.2-64.57.90.11.17
BGF World Mining Fund D4RF GBP-42.5NANANA1.791.32
Euromoney Global Mining TR Index USD-38.2-51.5-55.523.2

Source: Morningstar as at 17 September 2015

 

Putting the strategy into practice

While selling an investment at a loss to offset against future gains is beneficial for assets held outside Sipps and Isas you should not just sell an asset for the sake of the tax. Selling when something is down runs contrary to the accepted wisdom of buying assets when prices are low and selling when prices are high, eg after you have made a profit.

"Holdings that have just fallen a long way, for example at the moment in resources, emerging markets or Asia, may well have fallen too far," says Mr Sketch. "Our preference is to trim holdings that have done very well and to recycle cash into topping up holdings that are wholly friendless."

If you sell an asset first reinvest in an Isa or a Sipp if you still have your allowance left to get the tax benefits of these, and the option of reinvesting in the same fund or share. The current annual Isa allowance is £15,240 and the pensions annual allowance is £40,000.

Selling at a loss outside a tax advantaged wrapper could be a good option if you are looking to sell the asset anyway or do not expect the performance to improve. "We don't normally sell to get a loss, we only sell an asset if we can get a better investment, product or region," says Peter Lowman, chief investment officer at Investment Quorum.

If you are pursuing this strategy with investment trusts, it is not usually a good idea to sell ones which have fallen to a discount and switch into ones trading at a premium.

Make sure you have made a loss: just because a fund or share's value has fallen doesn't mean you have made a loss as you might have bought in a long time ago at an even lower level.

When you buy and sell shares or funds you incur trading costs. Also ensure that the fund you move into doesn't have an excessive ongoing charge.

If you carry forward a loss in future years you can only use it after you have used your annual capital gains tax allowance which is currently £11,100. If you don't think you will ever do this in any one year you may not need to resort to carrying forward losses.

If you buy back into a fund in the same sector there is not a lot of difference in the generic risks relating to the asset class. If you move to something in a different sector be aware of the different risks that you will be exposing your portfolio to.

If you are pursuing this strategy with individual shares bear in mind that companies in the same sector can vary from each other in terms of performance considerably. This is also true of active funds in the same sector, as some managers are more successful than others.

It is important that you replace a poorer asset with a better one so choose carefully what you sell and what you reinvest in.

Matthew Read, senior analyst at QuotedData, says that with investment trusts you could "screen for ones which have suffered big losses over a number of timeframes and those in asset classes that are more resilient when it comes to returning to fair value."

Ultimately your decision will come down to your individual circumstances as every investor’s portfolio is unique, as is your tax position and what you paid in total to acquire the asset.