The changes, if implemented, will put the taxation of bonds held in closed-ended funds on a par with equities and is likely to prompt new bond-orientated launches to capture this as yet largely untapped quarter of the investment trust market.
Michael Campbell, head of closed-ended funds at F&C, says the removal of this tax anomaly is good news for the investment trust sector. Currently it is tax inefficient to hold more than about 20% of a portfolio in bonds. As a result, most trusts do not have large weightings in fixed interest and similar interest paying assets.
Fixed interest funds
Campbell says new legislation would change this and open up the market to investors seeking income from low risk assets like bonds.
“We certainly expect to see some launches of bond funds in the closed-ended sector if the legislation if passed,” he says.
Nick Greenwood, chief investment officer at iimia MitonOptimal, agrees the sector should open up if the proposals are passed. He says many fixed interest strategies suit closed-ended structures although he believes riskier bond investments are more appropriate for investment trusts.
“I think the investment trust sector will suit more aggressive fixed interest trading strategies rather than funds invested in government bonds and so on,” he says.
Mixed asset funds
Meanwhile, Simon Elliott, an analyst at investment trust specialist Wins Research, says the UK’s aging demographic means yield is a key requirement for investors in today’s low interest rate environment, which could boost demand for closed-ended bond funds.
“These [tax] changes will lead to both existing funds investing in bonds and the issuance of new investment trust bond funds,” he says. “The closed-ended structure could be used advantageously, for instance to invest in less liquid issues or using gearing to increase yield.
Details of the legislation have yet to be finalised but government has invited input from the industry to help put together the final framework.
Campbell says it is important that the tax changes, which will offer an opt-in scheme for investment trust companies that already hold part of their portfolio in bonds, are simple from an administrative point of view.
“We’d hope the regime will be administratively quite easy for the end investor to deal with,” he says.
While the proposals should create a level playing field when it comes to investing in closed-ended funds, the tax changes will not give fixed interest orientated trusts immunity from arbitrageurs.
Greenwood says active investors are a healthy part of the investment trust sector and are just as likely to be active within fixed interest funds as they are in other trusts.
“Funds that have not been performing well are vulnerable and it doesn’t make a difference if it is a fixed interest or equity fund,” he says.