Got a Sharona
by Doug Brodie
/1. What would you guess is the most common annual % return from the FTSE All Share over the last 30 years?
You might recognise this question from our ‘retirement knowledge’ scorecard on our website. The All Share opened 1975 at 632, 50 years later it opened 2025 at 4,467. The gain is 3,835 over 50 years. That’s a return of 607% which is a big number, though it doesn’t tell us anything meaningful (see last week’s Investing Short). You and I are taught to use annual figures as reference points, so that return in annual terms is 3.99% per annum. That’s not brilliant – currently, you can beat that in cash but certainly not so ten years ago, or any time pre the ‘Lettuce’ Budget.
You could only get that return if you invested by a tracker fund: the important information is that the index is capital only, it’s had the income stripped out. What we need to look at is the total return index which includes that income – the trouble is it is little traded, little used and difficult to track in the retail market.
Over the last thirty years the All Share price index had an annual return of 3% per year, whereas the All Share total return index had 7% annual return – the difference being 4% per annum (does that ring any bells?).
This chart answers any ‘yes, but’ questions as to why we recommend income investing for retirement. Can you imagine trying to pick and choose when is a good time to sell down capital to fund your income, through thirty years of retirement?
As The Eagles recommended to you and me back in 1972, take it easy…
/2. How to gift wealth to mitigate IHT.
Let me help you clarify your thoughts here – however it may be dressed up, the only way to remove ‘stuff’ from your IHT liability is to give it away. IHT is charged on what you own, so you can’t keep it and hope no one notices.
There’s a frozen threshold of £325,000 that is IHT free, and that is per person (you and spouse/partner), on top of which you each have £175,000 as the residence nil rate band (your home), so £500k each, making David Camerons’ £1m per couple. Pensions are now to be included once the relevant Finance Act is enacted in 2027.
You can give as many gifts of £250 as you want, as long as you have not given other allowance sums to the same person (ie wedding gift or annual allowance). Wedding gifts are £5k per child, £2,500 per grandchild or £1k to any other person.
You can gift £3,000 to one person or several smaller gifts up to £3,000 in total to several people.
Mr Big Stuff
Give away pretty much any sum and it will usually fall into the 7-year rule of the ‘potentially exempt transfer’.
Give regular payments to another person, without any maximum, make those payments from your normal, regular monthly income and they are IHT free. Note – do not try and use capital pretending to be income, that will antagonise HMRC and they will start investigating everything. To maximise this, one of the things we can do is ramp up to the maximum income to be paid from a SIPP, but only using income-generating assets. In this way, you can strip down assets in a very simple IHT-free way. For example, £100,000 in an ISA will have an IHT charge of £40k, leaving £60k net. If instead, you held a riskier asset you’d not normally touch – a VCT-type fund for example – that pays out 10% per year, you’d only need 6 annual payments to your beneficiaries to match the net sum from the capital.
The very simple example for using the gift from exemption strategy is where the donor has sufficient final salary and state pension income, and has been holding the pension to hand on. Switch on a new pension income stream – which is not a disputed source of income not capital – and pay it away immediately. You just need to be aware of pension income tax at outset.
Teach your children well.
With luck and a favourable wind you may have a family of Mistress Sensibles when you head towards your dotage: the kids are getting everything anyway, so why not just hand everything over now? Do you trust them enough? You can even give away your family home as long as you then pay market rent – and why not? That rent is charged as taxable income in their hands but if you leave that cash in your bank account they’ll pay 40% IHT anyway.
£2m+ house? Be careful:
Inheritance tax rules for large estates over £2m are largely the same as other estates apart from the Residence Nil-Rate Band. In this case if the estate is worth more than £2m, the remaining spouse will see their RNRB tapered by £1 for every £2 that the deceased's net estate exceeds £2m.
/3. Understanding Henderson Far East Income
We had an enquiry from a person who was very distressed by the fact that he’d fired a disastrous adviser, took over his portfolio himself and bought this trust, only for the share price to collapse by 25%. That’s the chart you can see above.
If you’ve ever been caught by your partner using a kitchen knife to pry open a tin of paint you know how this goes.
The enquirer was looking at the trust using his binoculars the wrong way round. This is the income chart. I very much hope the person did not sell as all he’d have done would be to crystallise the capital fall, turning it into a loss. In the discrete year 2024 the share price rose over 19% and now the share is sitting at a 2% premium to NAV.
The charts are pretty pictures; the place you really need to start looking is in the annual reports and accounts. What you want to know is if the tide goes out will the managers be found to have been swimming naked?
The answer is indeed not. Excuse the mixing of metaphors but the dividend in HFEI is fully covered. The income in the ’24 accounts was £45,334,000 and the dividend was £37,052,000 – a 120% coverage ratio is a good thing, and this excludes the current £29,852,000 revenue reserve.
Don’t use a knife to open tins, don’t use this trust for capital.
/4. How the S&P 500 outperformed hedge funds – and it wasn’t even close
From aei.org/carpe-diem:
In 2007, Warren Buffett entered into a famous bet that an unmanaged, low-cost S&P 500 stock index fund would out-perform an actively-managed group of high-cost hedge funds over the ten-year period from 2008 to 2017, when performance was measured net of fees, costs, and expenses. See previous CD posts about Buffett’s bet here and here. In Warren Buffett’s 2017 annual letter to shareholders (released on February 24, 2018), he summarized the result of his bet in the section “’The Bet’ is Over and Has Delivered an Unforeseen Investment Lesson” as follows:
Last year, at the 90% mark, I gave you a detailed report on a ten-year bet I made on December 19, 2007. Now I have the final tally – and, in several respects, it’s an eye-opener. I made the bet to publicize my conviction that my pick – a virtually cost-free investment in an unmanaged S&P 500 index fund – would, over time, deliver better results than those achieved by most investment professionals, however well-regarded and incentivized those “helpers” may be.
Addressing this question is of enormous importance. American investors pay staggering sums annually to advisors, often incurring several layers of consequential costs. In the aggregate, do these investors get their money’s worth? Indeed, again in the aggregate, do investors get anything for their outlays?
Protégé Partners, my counter-party to the bet, picked five “funds-of-funds” that it expected to over-perform the S&P 500. That was not a small sample. Those five funds-of-funds in turn owned interests in more than 200 hedge funds. Essentially, Protégé, an advisory firm that knew its way around Wall Street, selected five investment experts who, in turn, employed several hundred other investment experts, each managing his or her own hedge fund. This assemblage was an elite crew, loaded with brains, adrenaline and confidence. The managers of the five funds-of-funds possessed a further advantage: They could – and did – rearrange their portfolios of hedge funds during the ten years, investing with new “stars” while exiting their positions in hedge funds whose managers had lost their touch.
Every actor on Protégé’s side was highly incentivized: Both the fund-of-funds managers and the hedge-fund managers they selected significantly shared in gains, even those achieved simply because the market generally moves upwards. Those performance incentives, it should be emphasized, were frosting on a huge and tasty cake: Even if the funds lost money for their investors during the decade, their managers could grow very rich. That would occur because fixed fees averaging a staggering 2 1/2% of assets or so were paid every year by the fund-of-funds’ investors, with part of these fees going to the managers at the five funds-of-funds and the balance going to the 200-plus managers of the underlying hedge funds.
The final scorecard for the bet is summarized in the top chart above. The five funds-of-funds got off to a fast start, each beating the index fund in 2008. Then the roof fell in. In every one of the nine years that followed, the funds-of-funds as a whole trailed the index fund.
Let me emphasize that there was nothing aberrational about stock-market behaviour over the ten-year stretch. If a poll of investment “experts” had been asked late in 2007 for a forecast of long-term common-stock returns, their guesses would have likely averaged close to the 8.5% actually delivered by the S&P 500. Making money in that environment should have been easy. Indeed, Wall Street “helpers” earned staggering sums. While this group prospered, however, many of their investors experienced a lost decade.
We agree. We have watched, read and investigated thousands of different funds over the years, and included many hedge funds. After all, people like Ray Dalio, Ken Griffin, Steve Cohen, James Simons, George Soros et al didn’t become billionaires through the lottery. There have been some fantastic returns; however, it would certainly appear that their wealth is made because they themselves have no down years – their investors’ capital can go down, can lose money, but the worst case scenario for the hedge fund entourage is they have to live on only the 2% flat fee they get paid.
That’s why they own the yachts, n’est-ce pas?