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Bond and beyond

Bumber offshore inflows are expected as confidence returns

The last 12 months has seen a reversal of fortunes for the offshore bond market, which has been transformed from a sector in retreat to one of the handful of areas of financial services witnessing genuine growth. Just a year ago, Aviva Life International pulled its offshore bond due to lack of demand. Fast forward to today and offshore providers are pred-icting bumper inflows and launching new products.

Aviva’s exit came after what had been a difficult time for the sector. Not only had the financial markets decimated fund values but the collapse of Kaupthing Singer & Friedlander Isle of Man left thousands of offshore bond investors wondering who was going to compensate them for the cash they had placed on deposit. And with the treatment of capital gains very negative for offshore bonds at that time, prospects for the sector were not great.

A year on and the picture has changed considerably. Confidence is returning to the market, a new CGT regime has increased the appeal of offshore bonds and, crucially, the coalition’s tax-raising measures are sending investors further afield in pursuit of tax breaks.

End-of-year figures for offshore new business volumes are not out for a few more weeks but last October, Association of International Life Offices members reported an 87 per cent increase in new business in the first six months of 2010 compared with the same period in the preceding year. Reported single-premium business stood at £6.1bn, 90 per cent of which were personalised and pooled offshore bonds.

It is a trend that providers expect to continue. Aegon head of sales development (pre-retirement products) Mark Hayhoe says: “We have high expectations for 2011 based on the pension legislation changes as offshore bonds will be considered a savings vehicle to complement pensions.”

April’s introduction of a £50,000 annual contribution charge will doubtless be the biggest single factor influencing UK offshore business this year. But just how much of the single-premium pension business that will be choked off by the £50,000 annual contribution limit will find its way into offshore bonds?

“I wish we knew but only time will tell,” says Skandia International marketing manager Phil Oxenham. “There are a lot of IFAs who have been specialist in the pension market who have not used offshore bonds very much. Also, you have got the emergence of maximum investment plans from onshore companies, which may well gain traction as well.”

A further reason why very wealthy people may be interested in the deferred tax facility offered by offshore bonds is the 50 per cent top rate of income tax.

Brooks Macdonald director Michael Owen says: “There is definitely an added incentive for the 50 per cent taxpayer. We are hoping that it will not be 50 per cent for ever, so if there is a way you can defer paying tax, then that will be attractive. For those who are already using their capital gains tax allowances and their CGT allowances and who are looking at paying 50 per cent tax on their earnings above the threshold, it looks great.”

It is not just the annual pension allowance and the 50 per cent income tax rate that are making offshore bonds look an attractive option for wealthy investors. While the New Year increase in VAT to 20 per cent will mean the taxman adds a fifth to the cost of discretionary fund management charges on UK assets, this will not apply to assets held within Dublin-based wrappers.

Owen says: “If you are paying 1 per cent plus VAT for discretionary management, the VAT will not apply where the investment is wrapped up in an offshore bond. That 0.2 per cent will go some way towards meeting the cost of the offshore bond.”

Providers say that the tightening of the inheritance tax noose, which is being achieved through a four-year freezing of the nil rate band, could also help the market on.

Friends Provident International head of marketing Peter Dodds says: “The fact that the inheritance tax threshold has been capped for four years can only make offshore bonds more attractive.”

It is an opportunity being targeted by Axa Wealth International, which has just extended its range with a legacy planning bond, a capital redemption product that allows income to be taken while passing wealth on in a tax-efficient manner.

But while IHT planning is a factor, for Dodds, the main reason for the rebound in interest in offshore investment is the rebound in equity markets.

“The main growth is simply in the return in confidence after the global recession,” he says.

That return in confidence is notable, given the questions being asked of custodianship of assets on offshore bonds at the height of the financial crisis. So are clients and, more importantly, their advisers forgetting the lessons of KSF too quickly?

“We cannot say because we have not surveyed IFAs to find out whether their attitudes have changed,” says Ailo marketing executive Christine Hall. “But the levels of business being done this year suggest that confidence in offshore bonds is returning. Investors are voting with their feet.”

Owen points out that things are different this time around, anyway. He says: “We cannot rule out the risk of further bank collapses. The issue back then was that all the cash held by the provider benefited from the Government protection scheme once only. But the situation has turned around substantially since 2008 so this is less of an issue now. Back in 2008, we had very low attraction for equities and high returns of 6 per cent for cash on deposit. Today, the situation is the complete reverse. But you still have to be careful about custodianship.”

Access to offshore bonds is also becoming more widespread, with some platforms now offering half a dozen different wrappers, allowing offshore bonds to be used in an unbundled way. “There is no point being tax efficient if you haven’t got investment flexibility, and vice versa,” says Hayhoe.

There are plenty of reasons why 2011 should be another year of growth for the offshore bond sector. With the Government looking to clear the deficit as quickly as possible, the attraction of taking cash offshore can only increase.

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