Irregular Roundup, 2nd October 2023

We begin today’s Weekly Roundup with pensions.

LTA

In FT Adviser, Sonia Rach reported on wealth management firm Quilter’s warning that Jeremy Hunt’s LTA reforms will impact tax-free withdrawals from larger pensions.

• This is hardly a shock, as the Chancellor made it clear in March when he abolished the LTA itself that tax-free cash would be capped at 25% of the former LTA (£1.07M, giving a cap of £268K for those with no earlier LTA protection).

Quilter has done some projections to show that over five years, those with “full” pensions will lose £37K in tax-free cash (in real terms), bringing their effective allowance down to 19% of their pot.

• Over 10 years they lose £70K and have only a 14% tax-free allowance.

These are sizeable impacts, but they are worth it for the removal of the LTA penalty on larger pots.

Roddy Munro, head of tax and pensions: said:

With savers already impacted by fiscal drag as well as the reduction in the capital gains annual exempt amount and the dividend allowance, now those with large pension funds will soon feel the full effect of the freezing of the amount they can take tax-free from their pensions.

The impact of the chancellor’s recent visits to the dispatch box will have major consequences for those who, through careful financial planning, have accrued significant pension wealth. The practice of fiscal drag, where tax thresholds and allowances do not keep track with increasing inflation or wage growth is not widely appreciated.

For some people, it will be worth crystallising pensions early, but with a £20K annual cap in ISAs, most of the tax-free lump sum will head into taxable investments.

• This means that it’s probably only a good idea if you have a good home for the cash (such as a holiday cottage, or a mortgage to pay off).

Quilter seems to be pushing insurance bonds as the best home for the money, but they don’t look attractive to me.

Pensions outlook

The outlook for pensions – and the LTA in particular – also came up at an FT panel at their Weekend Festival.

Former pensions minister Steve Webb was sceptical about any detail behind Labour’s plans to reinstate the LTA:

They have assumed that just because something can be abolished, if you just put the law back in, you have reversed it and everything goes back to how it was. But of course, the lifetime allowance doesn’t work like that.

I think they would set the ‘meter’ at some estimate of what you have consumed so far, and then you’d risk going over the reinstated LTA if you cashed out further pensions on top.

And he expects more fixed protection:

This has always happened in the past when the LTA has been cut. He speculated that if someone “filled their boots” before the election, pushed their pension over the old lifetime limit but did not draw on it, they would probably be able to lock in at a higher level.

Agreeing with my  suggestion above, the panel was against taking a lump sum without a plan for the cash:

It would bring the money inside their estate for inheritance tax (IHT) purposes, and it would no longer benefit from tax-free investment growth.

But David Goodfellow of Canaccord Genuity could see the logic:

For those who have crystallised benefits up to the current LTA by taking their maximum tax-free cash, it makes sense to crystallise the rest of their benefits at a time where there is a zero rate tax.

It’s hard to see a retrospective tax on crystallisation before the election.

Nimesh Shah, CEO of tax advisors Blick Rothenberg felt that Labour would struggle to introduce tax changes before April 2026:

Because of the tax complexity, the need for consultations and the long-term nature of pensions.

Elsewhere at the festival, shadow chancellor Rachel Reeves reiterated ruling out a wealth tax:

We have the highest tax burden since the second world war. I don’t wake up every morning thinking how can we introduce new taxes.

Diamonds

Buttonwood said that diamonds are losing their allure as an investment category.

• Which is a change from history:

A paper by Luc Renneboog in 2015,[found] that the average return between 1999 and 2012 rivalled those of stocks and property. Holders of diamonds would have earned a handsome 8% or so a year.

But recently, De Beers cut the price of 2 to 4-carat stones (which make 1 to 2-carat engagement rings) by 40% and announced that the “A diamond is forever” ad campaign would be restarted to boost demand.

• Demand tends to rise during economic uncertainty, but also in periods of prosperity (driven by their jewellery use).

The factor really driving prices has been supply – De Beers controlled 80% of it in the 1980s and stockpiled supplies to create scarcity.

• But now De Beers controls only a third of the supply, and artificial diamonds are a thing, with 10% of the market.

De Beers argues that, as the supply of lab-grown gems accelerates, the price gap between the two types of stone will widen. The tactic appears likely to backfire – mined prices are plunging in the wake of lab-grown ones.

Luckily, there has never been a cheap and easy way for UK investors to put money into diamonds.

Buy-write funds

In a second article, Buttonwood looked at the rise of buy-write funds.

• He starts with the market equivalent of Sod’s Law:

Markets will move in whatever direction causes the most pain to the most people. This year, [trader] have been vindicated by a soaring stockmarket that few saw coming, in which the biggest winners have been the shares that were already eye-wateringly expensive to begin with.

By which he means Big Tech.

• In June and July, in the face of the continuing rally, hedge funds abandoned their bets on a crash.

So what to do?

If you don’t think stocks can rise much more yet can’t stomach the risk of shorting them, logic dictates a third option. You can try to profit from them not moving much at all. A growing number of investors are doing just this—or, in industry jargon, selling volatility.

This is where the buy-write ETF comes in.

• These funds buy a basket of stocks and sell (write) at-the-money call options on them.

This is a bet on no movement in the price, in which case they pocket the option premium for free.

• If stocks rise, they lose all the growth and have to surrender their stocks.
• If stocks fall, the option premium offers some compensation.

Since the start of 2023, buy-write ETFs have seen their assets balloon by 60%, to nearly $60bn.

They are sold as income funds, with regular option selling generating a constant income stream.

The Global X Nasdaq 100 Covered Call ETF [has] over the year to June, each month collected option premiums worth 3% of assets and made distributions worth 1% to investors.

There is a catch, but it’s the opposite of the usual fear of stock market turbulence.

The nightmare scenario is that stocks go on a blistering bull run that buy-write investors miss out on, followed by a plunge that hurts them almost as much aseveryone else.

Better to buy at the bottom than the top, then – just like everything else.

• The real use for these funds would be to lower the volatility of a stock-heavy portfolio, whilst broadly matching returns over the long run.

Public debt

The Economist wondered how politicians would be able to escape the currently enormous public debts.

• The US borrowed 8.6% of GDP in the year to July, and by 2025 five of the G7 will have debts of more than 100% of GDP.

These debts look unsustainable with 10-year Treasuries at well over 4%.

Historically, governments have used two strategies to fix this:

1. run a primary surplus (surplus before interest payments on the debt)
   • modern welfare states and adverse demographics make this unlikely
   • so do increases in defence budgets and green spending
   • tax raises have a poor track record here, as they impact economic growth
2. have growth exceed the inflation-adjusted interest rate, shrinking the debt-to-GDP ratio
   • but only unexpected inflation helps here, otherwise bondholders demand higher returns (increasing the interest rate and the government’s bill)
   • the alternative is financial repression – holding down bond yields by buying government bonds (savings account interest was also banned after WW2 to redirect money to bonds)

Unless AI sparks a productivity boom, high growth rates look unlikely.

• And financial repression would require central banks to be relieved of their 2% inflation targets.

Yet if nothing is done, the US will have a record interest bill of 3.2% of GDP by 2030, which will increase to 6% by 2050.

• Something’s got to give.

British ISA

In FT Adviser, Tara O’Connor reported on calls from asset manager Premier Miton for a “Great British ISA“.

• CEO Mike O’Shea wants an extra £5K annual allowance dedicated to the British Economy.

There are 8.4 M people in the UK holding most of their assets of greater than £10K each in cash.

• Raising £5K from each of them would total £42 bn.

O’Shea said:

Ensuring companies have access to the capital they need will encourage them to scale up and list here in the UK. This will mean that companies’ headquarters, and all the associated high-paying roles, tax receipts and international prestige, remain here in the UK.

We think more British savings should be going into British companies. The GB Isa would fully unlock the potential of the City, to not only scale up smaller private companies, but to provide those same companies with an attractive listing environment to stay and grow here in the UK.

Quick Links

I have seven for you this week, all from The Economist:

1. The Economist pointed out the risk that America’s Federal Reserve could soon be flying blind
2. And said that Investors’ enthusiasm for Japanese stocks has gone overboard
3. And looked at Pharma’s big push for a new generation of obesity drugs
4. And wondered Can Europe’s power grid cope with the green transition?
5. And aid that America’s real fiscal worry is rising bond yields
6. And explained How Microsoft could supplant Apple as the world’s most valuable firm
7. And looked at The lessons from Microsoft’s startling comeback.

Until next time.