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Impact Investing for Family Offices

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Impact Investing for Family Offices

Introduction

Over the last year or so, we have witnessed more widespread evidence of increasing interest and awareness around impact investing both among our clients and contacts, as well as more generally in the media, market discussions and commentary.

It can prove difficult to track the extent to which proclaimed interest is being converted into executed investments and it is likely that the volume of capital committed remains relatively insignificant. However, the intent and appetite amongst investors, particularly family offices, across the globe, for stakes in impactful businesses looks to be fairly well established and on an upwards trajectory.

Why Might This Be Happening?

Many wealthy families have, of course, long been associated with philanthropy, often seeking a social impact via purpose-specific donations or endowments. Under this traditional model, these philanthropic endeavours would typically be undertaken entirely independently of the family’s commercial and investment activities. It is successful execution of the latter that generates the funds required to engage in the former, but there might otherwise be very little overlap or connection between the two concerns and, indeed, in some families that dichotomy might even extend to the individuals involved.

What appears to be happening more frequently, however, is that investors are targeting assets through which they can simultaneously make a positive social impact and achieve market or risk-adjusted rates of return. For reasons touched upon in this piece, these types of assets seem to be attracting family offices, in particular.

In the family office space, one of the most oft-cited explanations for this development is that we are going through an era of significant wealth transfer. As a consequence, the next generation of younger family members, who may be more socially conscious than their predecessors, are taking up decision-making positions and demanding that their family’s wealth be deployed in a way that benefits a broader group of stakeholders. While this seems to hold true across the world, it is most apparent in Asia, where a tremendous amount of family held wealth has been generated since the start of the new millennium.

Another observation is the rise of for-profit businesses and entrepreneurs that are developing innovative, tech-enabled ways to tackle specific social and environmental problems in the renewable energy, healthcare, and financial services sectors, among others. Whilst a widespread strengthening of social conscience is at the heart of this, the tremendous advances in technology, and/or perceived failings by the non-profit or public sector are also catalysts, with the overall effect that for-profit enterprises are increasingly finding market-orientated solutions to issues that historically may have been the preserve of governments and non-profit organisations. In some jurisdictions, we are also seeing this facilitated by other means, such as through innovative legal structures. These include the development and growth of the “benefit corporation”, or “B Corp”, in the United States and elsewhere, which enable directors to move away from a “shareholders first” fiduciary model and commits companies to promotion of the so-called “triple bottom line” (social, environmental and financial) approach to business.

It is these sorts of businesses that may present Investors with opportunities to invest capital for growth and profit as well as contributing social impact of which they can derive personal satisfaction. Funding and supporting these businesses as a financial partner, rather than as a donor, so they can continue to grow and innovate, may also be better for the overall ecosystem as, whilst some will undoubtedly succumb to market pressures and fail, the longer-term effect should be the promotion of self-sustaining, scalable enterprises that have a greater potential to survive and make a lasting, more profound, social impact.

Family Offices Are Well-positioned…But There Remain Challenges

Given its innate flexibility, family capital seems well placed for allocation to impact investments, especially those early-stage, higher-risk undertakings that might not otherwise be in a position to take investment from more mainstream, institutional investors. Family offices are also often able to provide the “patient capital” that is required to tackle many of the long-standing, global social and environmental problems. Unrestricted by investment mandates, return targets and fund life spans, wealthy families generally have the freedom to determine their own requirements as far as the return on investment is concerned, both economic and social.

On the other hand, family offices will not always have the resources or expertise to identify, monitor and support these businesses in, perhaps, the same way that more sophisticated or institutional investors would. Whilst there may be approaches to mitigate this through co-investments or investing through impact funds, this may preclude some family offices from investing directly in higher risk enterprises. Complexity relating to structuring and/or challenges relating to certain geographic locations can also present significant obstacles, making investments prohibitively inefficient in terms of the execution time/cost required. Whilst these hurdles are by no means unique to impact investments, they may be felt more acutely given the nature of the underlying businesses in the impact space.

An impact investor will also need to decide what kind of impact it wishes to make and then find a way to measure and assess the way in which an investee business provides that impact or value-add to society or the environment. This may not be straightforward. In instances, the impact itself may be somewhat intangible or difficult to quantify, which obliges investors to put considerable thought into determining the most appropriate methodology or units of measurement and how accurate data can be obtained and then purposefully interpreted. Non-financial metrics will be unfamiliar to some investors and that may bring its own challenges. Finally, as impact investing moves into the mainstream and more businesses inevitably position themselves as creating positive social outcomes, a degree of personal judgement may also be involved in deciding whether a business can truly have the kind of impact that the investor wishes to associate itself with.

Being able to assess and monitor impact in a meaningful way will also be important for governance and accountability purposes, both for investors and investees, and effective monitoring will help the investor with managing reputational risk/benefit. In addition, generating data that demonstrates clear and positive outcomes may also kick-off a domino effect of positive media  which has the potential to improve the overall environment for and narrative around impact investing, setting off the virtuous circle.

Looking Forward

Encouraging transparency from investors about their impact investments, raising awareness through public dialogue and the emergence of common standards and analytical tools may all assist with some of the difficulties facing investors, though impact assessment is likely to remain, to a degree, quite a subjective and imprecise exercise. However, with regulatory mandated reporting in some jurisdictions, classification systems – such as the UN’s Sustainable Development Goals which are becoming more widely adopted and understood, and the rise of ‘benefit corporation’ or “B Corps” systems –  significant progress in these areas is being made.

Notwithstanding the difficulties around defining and measuring the concept of impact, given the wider social forces at play, it seems likely that we are going to hear more from the businesses and investors involved in this space and can expect to see family offices playing a significant part in this story.

Robert Shakespeare is Of Counsel at Squire Patton Boggs, where his practice includes all aspects of corporate work including mergers and acquisitions, capital markets, joint ventures, group restructurings and funds structuring. He advises both public and private companies, partnerships and funds across a wide range of industries.

Investing

An outlook on equities and bonds

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An outlook on equities and bonds 1

By Rupert Thompson, Chief Investment Officer at Kingswood

The equity market rally paused last week with global equities little changed in local currency terms. Even so, this still leaves markets up a hefty 10% so far this month with UK equities gaining as much as 14%.

The November rally started with the US election results but gathered momentum with the recent very encouraging vaccine news. This continued today with the AstraZeneca/Oxford vaccine proving to be up to 90% effective in preventing Covid infections. This is slightly below the 95% efficacy of the Pfizer and Moderna vaccines already reported but this one has the advantage of not needing to be stored at ultra-cold temperatures. One or more of these vaccines now looks very likely to start being rolled out within a few weeks.

Of course, these vaccines will do little to halt the current surge in infections. Cases may now be starting to moderate in the UK and some countries in Europe but the trend remains sharply upwards in the US. The damage lockdowns are doing to the recovery was highlighted today with the news that business confidence in the UK and Europe fell back into recessionary territory in November.

Markets, however, are likely to continue to look through this weakness to the prospect of a strong global recovery next year. While equities may have little additional upside near term, they should see further significant gains next year. Their current high valuations should be supported by the very low level of interest rates, leaving a rebound in earnings to drive markets higher.

Prospective returns over the coming year look markedly higher for equities than for bonds, where return prospects are very limited. As for the downside risks for equities, they appear much reduced with the recent vaccine news and central banks making it clear they are still intent on doing all they can to support growth.

Both factors mean we have taken the decision to increase our equity exposure. While our portfolios already have significant allocations to equities and have benefited from the rally in recent months, we are now moving our allocations into line with the levels we would expect to hold over the long term.

Our new equity allocations will be focused on the ‘value’ areas of the market. The last few weeks have seen a significant rotation out of expensive high ‘growth’ sectors such as technology into cheaper and more cyclical areas such as financials, materials and industrials. Similarly, countries and regions, such as the UK which look particularly cheap, have fared well just recently.

We think this rotation has further to run and will be adding to our UK exposure. This does not mean we have suddenly become converts to Boris’s rose-tinted post-Brexit view of the UK’s economic prospects. Instead, this more favourable backdrop for cheap markets is likely to favour the UK.

We will also be adding to US equities. Again, this does not represent a change in our longstanding caution on the US market overall due to its high valuation. Rather, we will be investing in the cheaper areas of the US which have significant catch-up potential.

We are also making a change to our Asia ex Japan equity holdings. We will be focusing some of this exposure on China which we believe deserves a specific allocation due to the strong performance of late of that economy and the sheer size of the Chinese equity market.

On the fixed income side, we will be reducing our allocation to short maturity high quality UK corporate bonds, where return prospects look particularly limited. We are also taking the opportunity to add an allocation to inflation-linked bonds in our lower risk, fixed income heavy, portfolios. These have little protection against a rise in inflation unlike our higher risk portfolios, which are protected through their equity holdings.

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Investing

Optimising tax reclaim through tech: What wealth managers need to know in trying times

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Optimising tax reclaim through tech: What wealth managers need to know in trying times 2

By Christophe Lapaire, Head Advanced Tax Services, Swiss Stock Exchange

This has been a year of trials: first, a global pandemic and, now, many countries facing the very real possibility of a recession. For investors, private banks, and wealth managers, these tumultuous times have manifested largely in asset price volatility, ultra-low interest rates and uncertainty about when things may level out, as well as questions about what can be done to safeguard portfolio performance.

The answer here lies within identifying and creating efficiencies to maximise performance and minimise cost, and while there is a slew of options as to how to do this, they are often siloed or have a single USP. Tax optimisation, on the other hand, provides benefits to all, not just in increasing returns for investors, but also in creating economies of scale across stakeholders, creating millions – if not billions – in savings for banks.

Evolving tax reclaim

The tax reclaim process used to be a tedious one banks had to manage themselves, and required detailed, industry and country-specific knowledge to stay on top of constantly shifting requirements and regulations. And when we consider that many countries – such as the UK – allow for capital gains exemptions, tax optimisation may not seem like an integral part of the process. However, this isn’t the case for all countries, and can lead to severe after-tax implications on global portfolios.

Furthermore, even if you’re able to avoid double taxation, getting the money back is not always as simple as it sounds. This, combined with the fact that countries often have contradictory taxation rules or requirements, makes navigating the tax reclaim space a challenge even for those with the right expertise and experience.

Ultimately, providing tax optimisation to investors ends up being a heavy lift for private banks and wealth managers, who often don’t have the right solutions, are relying on outdated technology and manual processes. While this is generally fine for business, it is no longer fit for the purpose when it comes to tax optimisation. To date, knowledge and expertise have been the key to protecting and maintaining profitable investments and avoiding tax leakage. However, through tax optimisation services starting to emerge, portfolio managers can now manage and reinvest easily.

Today, technology has evolved the process so that banks are able to access and submit tax reclaim – and the relevant documentation – online, leaving the tech provider to coordinate next steps with custodians and tax authorities behind the scenes. In essence, taking the legwork out of the process while assuring consistency and completeness in execution.

Simplifying tax through tech

While tax optimisation may seem like an easy choice in theory, it is not always the go-to for every private bank or wealth manager. Without the right supports and setup, including innovative technologies and automation, tax reporting must be done manually, leading to labour intensive processes and huge time wastage. Changing these processes can be overwhelming for those used to a certain way of operating.

By making tax reclaim digital, banks will be more able to optimise returns and gain efficiencies while reducing redundancies and unnecessary complexities. Cloud based solutions or platforms can offer a safe and secure solution for banks, wealth managers, and investors to access and submit any information required, processing the data automatically for conformity and completeness.

It is critical that providers who intend to offer tax services are able to do so efficiently with the right software and data processing capabilities. Not only does this drive continuity in service and efficiencies in process, but it is the only sustainable way to handle such a complex landscape sustainably without wasting time or money.

End-to-end, technologically driven tax services offer a huge number of advantages to private banks and wealth managers, the most important of which is the ability to provide continuity through tumultuous times. As we move through the end of 2020 into 2021 this will only be increasingly important as banks, managers and investors look to provide new services to clients and strengthen existing relationships in a difficult market.

As investors seek to find returns amid the global economic downturn, the demand for innovative solutions will only increase. Technology like cloud-based software, AI, and data optimisation can all serve to improve not just the tax reclaim processes, but the overall client experience within capital markets.  Private banks and wealth managers are suitably equipped to provide these innovative solutions, but those who do not prepare themselves effectively and keep ahead of trends will run the risk of losing current and new clients to someone who can offer more for less.

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Equity Sharing – How do you choose the right plan for you?

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Equity Sharing – How do you choose the right plan for you? 3

By Ifty Nasir, co-founder and CEO of Vestd, the share scheme platform

In a survey of 500 SMEs, nearly half told us that the pandemic had made them re-evaluate how they operate. That’s not surprising as they’ve been faced with some unique challenges this year. Government support during the early stages of the pandemic, is now being extended till March 2021 but many businesses continue to struggle.

Making good people redundant improves cashflow in the short term but will have a long-term damaging impact on the business. At the same time, motivating employees, who are working remotely and worried for their jobs, is not easy.  It’s therefore not surprising that equity sharing, in the form of ‘share’ and ‘option’ schemes has become even more popular, with one in four SMEs now sharing equity with their employees and wider team

However, sharing equity can be a complex area and is easy to get it wrong. When it goes wrong there is a danger that you create tax issues (for you and your employees), de-motivate your team and even create future funding issues for the company. It is therefore really important that you choose the right scheme to set-up, but make sure you manage it too.

Below is a brief summary of the main schemes used by Start-ups and SMEs in the UK today. There are similar schemes and considerations globally.

  1. EMI Option Schemes – This is the most tax efficient scheme. Recipients pay just 10% Capital Gains Tax (CGT) on any value growth. The employer can also offset both the cost of the scheme and the value growth achieved by employees against its Corporation Tax  liability. You can also set conditions to control the release of equity, such as time served or performance. The recipient can’t simply walk away with shares, having delivered no value (which is one of the top concerns of many of the businesses and founders we talk to).  EMI Option Schemes are used by 41% of SMEs (who share equity) and, for good reason, are the most popular. Read our full guide to EMI for more information.
  2. Ordinary Shares  – This is the issuance of  full ordinary shares in the business, often without conditionality and with immediate effect. They are most often issued against cash investment. Once an employee (or any other recipient) has ordinary shares, you have no control over what happens to the shares thereafter. The individual can simply walk away with the shares, so we don’t normally recommend them for contribution that’s yet to be delivered. They’re also not tax efficient, as the recipient will have to pay tax at their marginal Income Tax (IT) rate, on any value the shares have at that point. These are used by 31% of SMEs.
  3. Growth Schemes  – These are a good option when the founders have built value into their company. The recipient only shares in the capital growth of the business from the date that the shares are issued.  You can give growth shares to anyone (not just employees) and you can attach additional conditions. These shares limit the risk of the recipient having to pay income tax on receipt of the equity, as they do not hold any value when they are issued but do pay CGT on the value growth at sale. Growth schemes are used by 31% of SMEs. Read the full details on Growth Shares here.
  4. Share Incentive Plan – SIP –  This is a tax efficient plan for all employees that gives companies the flexibility to tailor the plan to meet their needs.  Share Incentive Plans are used by 23% of SMEs.
  5. Unapproved Options – These are not very tax efficient as the recipient will pay IT on any value inherent in the share, above the exercise price, when they exercise the option. That said, they do provide more flexibility than the other options and are the easiest to set up as you don’t need HMRC approval. Unapproved Options are used by 22% of SMEs.

Is it worth the hassle? Earlier this year (i.e. during the first lockdown ) we carried out a piece of research with  business leaders,  exploring their attitude towards sharing equity with employees and wider team.  We spoke to over 500 owners of SMEs and identified six main business benefits to doing so:

  • Recruitment. You can combine salary with equity, to create compensation packages that match, or improve on, offers made by other more established companies with deeper pockets.
  • Retain the best talent. Share schemes are proven to increase employee retention and can help you reduce if not avoid hiring costs.
  • Increase productivity and performance. Studies have shown that employees who are also shareholders are more committed to their work and contribution because they feel directly vested in the growth in value of ‘their’ company.
  • Improve employee engagement and happiness. The more all employees feel included in the mission, direction, and success of the business, the more they’re motivated to contribute to the company.
  • Relieve cashflow pressure. Equity can be used to reduce the need for finance. Instead of paying people top rates and large bonuses, you can incentivise them via shares or options…giving them a share of the future they are helping to create.

Recruitment and retention are clearly the key drivers. It’s not too surprising to see why. Companies succeed or fail largely due to the quality of the people they manage to attract and retain. However, for smaller and start-up employers, attracting the right people can be difficult.  Good people are typically attracted to the idea of working for a house-hold name brand, they look for job security and are enticed by comprehensive employee benefit packages and high salaries that are unaffordable by most smaller companies. Employee share schemes are an effective way for smaller companies to compete in the job market against larger companies, with that potential for a massive/significant upside.

However, at this challenging time, it’s not all about money, keeping people focussed and motivated during the pandemic is at the top of most employers’ worry list.  If you choose the right scheme, equity sharing encourages employees to align their motivations to that of the long-term success of the business, over the immediate or short-term gains. And, right now, that is perhaps worth more than anything.

If you’d like to get into the detail then check out our guide to employee share schemes.

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