The £8m losses by Octopus in one of its low-risk EIS products is a “wake-up call” for the industry and should highlight the riskiness of the product to advisers, warns Enterprise Investment Scheme Association director general Sarah Wadham.
Investors who don’t understand enterprise investment schemes shouldn’t buy them as they can lead to big losses that not all can afford, experts warn. “It is not just about losing your money but more about the appropriateness of who advisors sell EIS to”, says Wadham.
The warning comes after VCT and EIS provider Octupus Investments is facing up to huge losses when an EIS marketed as low risk bled almost £8m over four years.
Around 170 people invested £18.3m in Octopus EIS 2. The investment vehicle has almost halved in value since 2011, with nine out of 10 firms it invested in losing money.
“What happened to Octopus, the leader in the EIS space, is certainly not good for the industry,” adds Wadham. “Obviously when we have something like this the whole industry suffers, it is a wake-up call for everyone you can’t just pretend it isn’t a risky product.”
EISs offer generous tax breaks to encourage investment in smaller, privately-owned businesses. Since April 2011 investors in the schemes get 30 per cent income tax relief provided the investment is held for three years.
However, Hargreaves Lansdown senior analyst Laith Khalaf, questions the branding on the Octopus product. ”I find it hard to see how an EIS can be described as lower risk with a predictable return while investing in start-up companies,” he says.
“Investors and advisers are attracted to these products because of the generous tax breaks but they need to spare more than a thought for the investment proposition too. It is important not to let the tax tail wag the investment dog.”
The whole point of the tax break of EIS is to promote investment in start-ups and small companies, but “advisors should know their customers, that is why there are restrictions [on investors],” says Wadham.
“The FCA has made clear these products are only sold to either sophisticated investors who know what they are doing: high-net-worth individuals or people who have an advisor who can judge whether their customers should be in these products. It is up to the advisors to make it clear that there is a risk of losing your money and that you won’t necessarily get your money out at any time that suits you.”
Informed Choice managing director Martin Bamford says investors should only consider EIS “as a last investment option”.
He says investors in this market have to be prepared for the risk of total loss. “It is not just about the investment’s risks but your capacity for risk,” he says, before recommending EIS to a lot of their clients advisers should know everything about the risks involved.
Wadham agrees with Bamford saying it is a question of advisors doing their homework and looking at the documentation about the products, asking questions of the managers.
Octopus’ EIS 2 invested in the media industry, including unquoted film and music rights companies, between February and April 2011.
The concentrated nature of the EIS may have had a hand in its downfall, says Wadham.
Schemes that focus only on one niche industry are not a good idea as they can’t spread the risk, says Wadham, although investors should be spreading their risk among more than one EIS product.
“If it is a total disaster and you lose a lot of your investments you do get loss relief and hopefully you haven’t put all your funds in just in one product you’ve spread it over different product, which is what you do with any investment.”
However, Octopus says it diversified EIS 2 by investing in more companies: “We highlight diversification as a key risk within the EIS product brochure. The product brochure for [this fund] stated that we would invest investors’ money in a portfolio of at least five EIS qualifying companies.”
Octopus adds that the losses should not come as a surprise to investors as the fund has “been underperforming for over a year, which has been communicated to our investors in our valuation reports and updates”.
Wadham points out that since 2011 – when this Octopus EIS product was launched – the industry “has got much better” with many EIS managers “doing a very good job”.
The earliest the fund can be liquidated is early next year. In the meantime, Octopus will remain investing in the companies, saying the valuations could go up.