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Paif the way to an extra 20%

Property funds are at last converting to the more investor-friendly Paif structure now that administrative hurdles have been resolved and a capital gains tax risk has been removed


Property fund managers are busy trying to convert their property funds into a new structure, one that will give investors an immediate 20 per cent boost in income. M&G was the first to make the transition earlier this year with its Property Portfolio. Other groups are sure to follow but the road to conversion is not an easy one even though the Property Authorised Investment Fund structure has been available to companies for many years.

The Paif was originally introduced in 2008 to allow a more even tax playing field between Reits and bricks and mortar authorised unit trusts (or less, commonly, Oeics). Property fund managers in the case of the latter have to withhold 20 per cent of the rental income for tax purposes. In a Paif, it is taxed in the hands of the investor. This is advantageous for investors such those who hold the fund within an Isa or pension wrapper as they would be unlikely to suffer the tax at all.

According to property managers Hearthstone: “This is a fundamental benefit of Paif status: without which, the fund would just be a ‘normal’ Oeic and would suffer the Oeic 20 per cent rate of corporation tax on these returns, which would ultimately be suffered by the investor in the form of reduced investment returns and which could not be reclaimed by ‘gross’ investors such as pension funds and charities.”

The bottom line is that in a straight comparison of an Isa investor in a Paif versus a property Oeic, the Paif will distribute 20 per cent more, providing an immediate increase for investors without additional risk being taken by the manager in the underlying portfolio.

For example, take two identical bricks and mortar property funds – one using a Paif structure, the other an authorised property unit trust; both with a net yield of 4 per cent. According to M&G a £10,000 investment in each would provide an Isa investor £500 in income from the Paif versus £400 from the other.

It is also worth noting that in a Paif three forms of income are streamed to the investor: rent, dividends from equities and/or interest from cash or bond holdings.

Despite the obvious benefits of the Paif, take-up has been slow to almost non-existent among UK asset managers. This is because in part few platforms have been able to administratively handle the more complicated Paif structure, although that situation is now largely being resolved.


Perhaps the most vital hurdle for the Paif adoption has been that existing investors could have been subjected to a capital gains tax hit. This is because of the need for a Paif to use a feeder mechanism, allowing managers to separate out eligible investors from ineligible ones, to account for the tax and income streaming difference. If a fund converted and an investor – based on their eligibility -switched, they could have been deemed to be disinvesting and a CGT liability may have arisen. However, that concern has since been put to rest as last year HMRC amended its rules allowing investors to switch from a feeder fund into a Paif and vice versa without incurring a CGT liability.

Even without this concession providers without legacy investors have elected to launch new funds under the Paif structure owing to its obvious advantages for investors.

Hearthstone’s UK residential fund launched last year was among the first. However, with more to do the larger, established retail funds have been making plans since the HMRC CGT clarification last year. There are ongoing plans among many of property managers, including the likes of Threadneedle and Aviva.

Andrew Watson, director of advisory and partnership sales at M&G, does not disagree that administratively the conversion is complicated. Highlighting just how intricate, the M&G Property Portfolio has about 6,200 investors and some 40 per cent of the fund’s £2.1bn assets under management should be getting gross distributions (those eligible to get the 20 per cent tax back) with the balance getting net distributions (that is not eligible). Segmenting the fund by client type (where one platform would be one client) about two thirds of investors are direct Isa investors, according to the group’s figures.

“We worked on it a long time,” Watson says. “However, in a world where income is difficult to come by, why would you not make your property fund as tax advantageous as possible for investors?” Watson adds he would not be surprised if, within the next 12 months, the majority of legacy property funds use the Paif structure.

While the whole trend is a positive for investors, one thing that may cause initial confusion is the knock-on impact Paif conversion will have on the constituents of the IMA Property sector. As Paifs use a feeder fund they are essentially multiple products with a central portfolio, albeit, with a slight return difference. As more groups convert the numbers within the IMA Property sector will increase and Paif/non-Paif status will become an important differentiato

According to FE Analytics there are currently 43 funds in the IMA Property sector, however, many of these are invested in listed properties. Currently it is those exposed to property equities that dominate the peer group in performance terms over the past year. The difference is stark with the top performer over the 12 months to 7 May, Henderson Horizon Asia Pacific Property Equities, returning 59.42 per cent while at the bottom of the sector bricks and mortar funds are by and large in negative territory.

Recently though the physical property sector has seen renewed interest. Although commercial property has experienced a tough five years, Watson says returns are normalising and income remains an attractive draw. He notes the M&G fund has seen “good steady flows.”

Property investment trust managers concur. Robert Boag, manager, UK Commercial Property, says: “Direct property investment has remained competitive against other asset classes over the long term. This resilience is attributed to the solid income return the asset continues to deliver which offers protection against inflation. In recent times it has reasserted its credentials as a genuine diversifier of investment risk between asset classes.”


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