Forward Diary

SIPPs - Managing your SIPP

Combining the tax advantages of a personal pension with the flexibility to invest in a wide range of markets, the SIPP is a powerful product indeed The SIPP is such a brilliant financial product that it’s a wonder the powers-that-be ever let it come into being. It combines the substantial tax advantages of a personal pension with the ability to include anything most individuals would ever want to invest in – with the notable exception of residential property. The result is a product so flexible that at one level it can be used by modest savers wanting a simple, low-cost pension plan while at the other it can be tailored creatively to meet the specific needs of any number of different individuals, from the moderately well-off to the wealthy. Someone, though, has to manage the money. How this is done is up to you. There are basically three ways to run the portfolio: 1.You can manage the investments yourself. If you are buying and selling shares directly, you will need to have a stockbroker, who will charge for each trade you make. However, if you are restricting yourself to funds, these can be bought through intermediaries such as IFAs and fund supermarkets or direct from the fund management groups.
 2.You can appoint an independent financial adviser or stockbroker to provide you with investment advice.
 3. You can appoint an investment manager, usually a broker, on a discretionary basis – that is, they take all the investment decisions without having to refer them to you first. If you are asking a broker to manage the money for you there will be a charge for this, and likewise if you set up an advisory account. It is difficult to generalise on investments in a SIPP, as the range of possibilities is so wide – from the simplest of structures to a complex plan tailored to an individual’s circumstances and specific tax considerations. If you are likely to fall into the second category, however, it is almost inevitable that you will have arrived at the SIPP on the basis of professional advice, from an independent financial adviser, wealth manager, accountant or solicitor, and the portfolio will be planned at least partly using their expertise.   Choosing the investment mix Most SIPP users are somewhere in the middle of the investor spectrum, with enough money to invest to make it interesting but not so much that they’ll keep financial advisers burning the midnight oil. Much of what has already been said about managing ISA investments applies to SIPPs. The main difference is that SIPPs have a more specific primary focus – to fund a retirement income – and for that reason tend to be taken out predominantly by people in late middle age (although, of course, it is never too early to start pension saving). As with any investment strategy, asset allocation is a key consideration. This means deciding on the mix of cash, shares, property, fixed interest, commodities and alternative investments. Different types of assets behave differently in different economic conditions and you should spread the investments to improve your potential for making profits and reduce the risk of making a loss. The choice will depend to a large extent on your attitude to risk and the time left until you draw down your pension – the longer you have, the more risk you may feel able to take.   Lack of adventure As it’s your pension you’re providing for, you may prefer to leave your more adventurous investments outside the SIPP. There are a number of asset allocation models and risk questionnaires around which can give you a good starting point. It is normally recommended that you hold a diverse portfolio of assets. The split and appropriateness of different asset classes will depend on a number of personal factors, such as your attitude to risk, the amount of money available to invest and time horizons. Generally as people move closer to retirement, the amount in higher-risk investments is likely to reduce – specially for those who are planning to buy an annuity. It is sensible to do this on a gradual basis over a period of, say, 10 years. By switching gradually, you can exit investments at an average price over the period rather than at the top or bottom of the market. Those intending to take income through draw- down will need to have a broad spectrum of investments, with perhaps around 15-20% in cash to fund their short-term income needs but having some exposure to equities and perhaps property to retain the purchasing power of the fund. Can you beat the fund managers? The SIPP structure gives you the ability to run the portfolio yourself, if you wish, or to stick to funds run by a professional manager. Whether an individual SIPP investor can beat the professional fund manager depends partly on the time the investor can dedicate towards understanding the different asset classes available and how to construct a portfolio geared towards achieving his or her financial goals. SIPP investors need to consider whether they will continue to have the time and access to information required to properly research and monitor their investments. Given the amount of information on funds and shares now available online, doing your own research is certainly not the problem it used to be but it can still be demanding. For those who follow the markets on a daily basis and are active investors, though, the benefit of a SIPP is that it can exactly reflect the needs of the individual. The question of whether it is possible to beat the fund managers depends largely on the areas in which you choose to compete. When it comes to simple index tracking, an Exchange-traded fund (ETF) will often provide closer tracking than a tracker fund and at a lower cost. Active management is a different matter though. Where fund managers often come into their own is in niche markets, where information is less readily available to the retail investor and trading in individual stocks is not always practical. Running a UK stock market portfolio is eminently achievable for many of us, and even an American or European portfolio is not beyond the powers of many a lay investor. However, when it comes to emerging markets you will find it almost impossible to do the job of a professional fund manager. Remember, though, that just because a SIPP allows you to invest directly, there is no shame in deciding you would rather stick to funds. Even a modest-sized unit trust or Oeic will have several million pounds of assets under management, so you are unlikely to be able to match the spread of risk doing it yourself. Perhaps the biggest advantage of a SIPP over a standard personal pension is that it allows holders to avoid poorly- performing fund managers – and there have been some real dogs out there among the traditional life and pension companies. The poor returns provided by many of these restricted products in the past have in turn impacted on their customers’ retirement incomes.   Now you are free to choose exactly which funds you want to invest in and potentially boost your eventual pension. It’s therefore not necessarily a case of beating the fund manager but using your SIPP freedom to reject poorly-performing managers in favour of the best of breed. Offensive versus defensive strategies SIPPs are one of the few retail savings products that give you the ability to cater for all scenarios and market conditions and also allow for the investor’s changing needs up to and into retirement. Volatile markets over the last few years have led SIPP investors to be more active in deciding how and where their money is invested. Many clients who have traditionally been buy-and-hold investors have become increasingly comfortable taking a more active approach – perhaps trading monthly rather than simply reviewing their portfolios every six months. Being more active has helped many SIPP investors to achieve ‘alpha’ returns – in a nutshell, beating the market. When confidence in cash plum-
meted – partly as a result of record low interest rates 
the retail investment market became more dynamic, with investors moving money around and diversifying where possible. It is too simple to talk of offensive versus defensive strategies, though – in fact they can often work well in tandem. For instance, if you think markets could be headed for another fall over the coming year it could be a time to look at good stock-picking fund managers – those who get their performance from being able to choose good companies rather than relying on overall market sentiment – and run their funds alongside some passive investments. Nervous investors who were burned by the 2008-2009 stock-market meltdown piled into bonds and ETFs in an effort to tone down risk and generate stable income. In particular, ETFs tracking inflation-protected bonds and corporate debt saw cash flying through the door, reflecting the trend of more SIPP investors using ETFs to man- age the fixed-income side of their portfolios. At the time of writing, there was a strong feeling among many professionals that bonds were looking overvalued after a good year and that with the prospect of interest rate rises, they were becoming a riskier proposition. One option for those sharing these concerns would be to move money into strategic bond funds, where the fund managers have the ability to defend against the prospect of capital loss from a bond market reversal. ETFs and their place in the portfolio
 It is often easy to pigeon-hole SIPPs as vehicles for active investors but they can be used across a wide rangeof strategies. In the past, clients wanting to adopt a passive strategy might have considered areas such as with-profit funds, managed funds and perhaps more recently structured products such as guaranteed equity bonds. All are still used extensively and hold billions of pounds of investors’ money. However, the range of investment vehicles is evolving and among the most topical are ETFs – Exchange-traded funds. A relatively recent innovation available on the stock exchange, ETFs allow you to in effect buy an index and trade it like a share. There are also ‘short’ they offer the efficient pricing of unit trusts with the efficient dealing of investment trusts. Another variation is Exchange-traded commodities ETFs which work the other way around – when an index drops, the value of your investment rises. An ETF represents a portfolio of
securities – which can be stocks,
bonds or other assets – that tracks
the performance of a specific market index. One advantage of ETFs
is the cost, with the lowest annual
charges of all collective investment
schemes – and for this reason ETFs can provide a more attractive alternative to index-tracking unit trusts. Efficient pricing The price of an ETF is always visible and very close to the value of the underlying market. They are traded on an exchange, just like shares, and can be bought or sold through a broker at any time during market hours.  In short, (ETCs), which offer exposure to everything from individual commodities such as gold, oil, wheat and corn, to baskets such as agriculture, livestock and all commodities. Many SIPP investors tracking a range of indices see ETFs as a low- cost solution that provides easy exposure to different markets or sectors. The choice available continues to grow and SIPP investors are picking up on this.
It is also worth pointing out that while they are increasing in popularity, ETFs are rarely available as an investment option under a traditional personal pension. SIPPs remain the main route for pension investment of this type. Commercial property in a SIPP Investing in this sector could be a minefield for novice investors. There are potential difficulties in sourcing a surveyor, broker and SIPP that will enable them to identify and invest in commercial property opportunities – not to mention the charges and ongoing property maintenance and insurance costs.
Investors looking for an easier and potentially cheaper way to invest in commercial property could consider investing in real estate investment funds, where a wide selection of properties are chosen and managed by experts. This option allows for diversification and a decent return potential, and also lowers the risk factors involved. But for some, investing directly in commercial property has a distinct appeal, simplifying property management and producing better investment returns. A SIPP can be a highly tax-efficient route for property investors, with no capital gains tax on growth in the property value and no tax payable on the rental income. On top of that, the ability to gear up the investment can make it very attractive for certain people. For example, an investor with a £200,000 SIPP fund might borrow up to 50% of that. In addition they may have received 40% tax relief on the contributions made, so a net outlay of £120,000 could allow a property purchase of £300,000. There are some downsides, however. Firstly, as the investment is within the pension fund, realisation of any gains and access to the proceeds is limited until the age of 55. Also, investing in a single property carries a greater element of risk. There is also a danger that SIPP investors fail to take account of their true exposure to property in general. Given that most people’s largest asset outside of a pension is their own home, investing most or all of a pension in real estate could leave you too widely exposed to one asset class. Despite this, property purchase is a popular move among SIPP investors and the range of property available to them is wide – even if residential real estate is pretty well out of bounds. You may consider the main commercial property categories of offices, factories, warehouses and shops. Land and commercial forestry is another option. Or there are the more specialised categories such as medical centres, dental surgeries and vets’ practices, hotels, leisure complexes and nurseries. The residential property exclusion also applies to holiday accommodation. Providers will also be chary about land or woodland that lies near or next to your home. Property can be freehold or leasehold and purchased with or without borrowing. The SIPP may purchase it directly from the member, his or her business, family and friends, as well as unconnected sellers. Jointly-owned property is permitted. Property can be transferred ‘in- specie’ into a SIPP, rather than making a cash contribution, with tax relief received on the capital value (in specie transfers need to be handled carefully, however – for more on these see chapter 11). Fixed interest investments Any portfolio should benefit from a grounding in fixed income, ie. gilts, government bonds and corporate bonds. With larger amounts it’s easier to invest directly, but keep in mind that, as with any investment class, diversification is still important. As the LSE’s retail bond platform gathers momentum, diversification should become easier for the individual investor who wants to invest direct. The main route for private investors has long been bond funds, but now ETFs also cover the fixed income market, offering the benefit of intraday trading, low unit values and low charges. Experts suggest that those within ten years of their intended retirement age should begin to invest in lower- volatility assets such as gilts and corporate bonds which match the income streams they will need after retirement. However, some people may be able to take on board more risk if they have other income or assets. The best strategy is the one that fits the needs of each individual, their attitude towards investment risk, their age and their other sources of income in retirement. You can read more about bonds in chapter 13. Keeping down the charges Focusing on investment returns is fine but minimising the costs of running a SIPP portfolio is important too. After all, the lower the costs the more money is eventually available to fund a pension. As explained earlier in this guide, many SIPP providers charge for similar services in a slightly different way, making it hard to draw a like-for-like comparison. However, there are a number of websites that attempt to help investors. Charges aside, investors should consider other important service aspects offered by the provider such as whether they offer free investment advice, how efficient and responsive they are to enquiries, and the range of online tools on offer to help make investment decisions. Dealing costs for online SIPPs have become very competitive and initial fund charges are discounted to little or nothing in a great many cases. Geared investments For more sophisticated investors, active traders and those with a higher risk-reward tolerance, the ability to include leveraged investments within a SIPP may be one of the key attractions. One of the main avenues is CFDs – contracts for difference – which can be included in a SIPP as long as the underlying asset is traded on a recognised exchange. As its name suggests, a CFD is a contract under which the holder is paid the difference between the starting value of an asset and its value when the contract is closed. CFDs may be used to go long or short–that is to buy an underlying security with the aim of making a profit if its price rises or to sell it to make a gain if the price falls. Gearing or leverage is a key element of CFDs, as with derivative products in general. It involves trading on margin: that is, you only pay part of the full cost of a trade when you open it, getting greater exposure to the market without increasing your initial outlay. If the trade goes in your favour, then your profits are increased, although if it goes against you so are your losses and you could face a ‘margin call’ from the broker asking for more funds to cover losses. However, as explained below, there are restrictions on the use of CFDs within SIPPs which limit the amount you are permitted to lose. There are no set expiry dates for CFDs – they can be closed at any time. However, for positions that remain open beyond one trading day, you pay a daily funding charge on long positions and receive interest on short positions. The result is higher charges if you leave a ‘buy’ position open for too long, which can be uneconomical – though
 with low interest rates this is less of an issue.   Charges on CFDs are usually collected via commission rather than the spread – typically 0.1% of the deal value. Partly because of this, a CFD will tend to track the price of an underlying share or market relatively closely. In effect, the CFD allows you virtual ownership of a security without actually holding it. Equity CFD holders are entitled
to any dividends paid by the 
underlying company during the
contract’s duration. The broker
will trade in the underlying shares
to match CFDs sold. CFD traders
mostly trade deals of £10,000 or
more, requiring margin from £1,000 up for each trade. Turbos Listed CFDs, also known as Turbos, can be traded on the LSE like shares and may also be held in a SIPP account. Unlike normal CFDs, the risks with turbos are limited to your original investment. Tactically, the general impression of CFDs is that they are high-risk instruments used by traders for short-term speculation. However, they also have a strategic role with- in a portfolio as tools to help lower overall risk. If, for example, you were worried about the near-term outlook for the stock market but reluctant to sell a large number of UK shares in your portfolio, you could ‘go short’ on the market using index CFDs so that any drop in the market would deliver gains to offset the fall in value of your shares. The downside of this is that if the market didn’t fall as anticipated, your short CFDs would negate much of the profits from any rise in the shares. Trading CFDs within a SIPP is slightly trickier than normal trading as under HMRC rules losses must not exceed the portion of the fund allocated to CFDs – otherwise they could jeopardise the whole SIPP and result in an unauthorised payment charge from HMRC. Because of this, investors will need to buy guaranteed stop losses, which close a trade once the loss has reached a certain level. Stamp duty saving Using a CFD, you pay no stamp duty, saving 0.5% on UK stock market trades. Given the tax-efficient treatment of SIPPs, there is no capital gains tax to pay on any profit and, of course, investors receive tax relief on contributions paid into their pension fund. To trade CFDs within your SIPP, you will need to notify your SIPP provider of your choice of CFD plat- form and instruct the provider to transfer a proportion of the fund to a cash account with the broker once the necessary paperwork has been completed. The broker must be UK-based and FSA-regulated. Not all SIPP or CFD providers
will allow trading within a SIPP, so
you may need to shop around for
those that do. The SIPP providers’
main worry here seems to be that as
they act as the trustees, they could be
held liable if a client were to fall into
a negative balance. However, you
should be able to find companies
that will enable you to trade CFDs within a SIPP–mainly in large UK stocks but also to an extent in the US share market. If you already have a SIPP there are two things to check with the providers: first, that they will allow the use of the instruments you are interested in, and second whether they recognise the broker that you plan to use for trading. Other financial derivatives avail- able to SIPP investors include futures, options and covered war- rants. Foreign exchange is another market commonly used by active traders which is available within a SIPP. These instruments may be used by sophisticated investors to hedge against falling markets and currency risk as well as speculating on short-term price movements. Like CFDs, these tools are really only for those who know exactly what they are doing, and in fact the bulk of users are those with professional experience. If you are considering using any of them, it is highly recommended that you take independent financial advice first. As with CFDs, not all SIPP providers will allow these instruments to be used by clients and in the case of futures and options the list of those willing to do so is more or less limited to specialist trading firms. Covered warrants Covered warrants tend to be more widely accessible via SIPPs than other derivatives. They have a certain amount in common with CFDs in that they allow investors the option to go short if they wish and their price movements magnify those of the underlying assets. Like CFDs, covered warrants can be used to protect a portfolio against falling markets. However, unlike CFDs any loss on a covered warrant is limited to the amount that you invest. As with any geared instrument, a relatively small movement in the share price of the underlying asset will result in larger movements in the value of the warrant. Therefore, covered warrants provide the opportunity for greater returns than ordinary share dealing but also greater risks and potential losses. Covered warrants enable you to take a view on assets including shares, indices and commodities. They are listed on the London Stock Exchange, so are highly regulated and easily accessible during trading hours. An investment will have a fixed life with an expiry date typically three, six or 12 months in the future. Wilder shores Because of their flexibility, SIPPs lend themselves to any number of idiosyncratic investment styles and strategies. There are plenty of providers able to offer creative ideas or tailor bespoke portfolios to your needs. For example if a ‘green’ SIPP is what you want, there is a scheme available that focuses on bamboo production, sustainable hard- wood, farm land and sustainable agriculture. Whatever you do though, don’t lose sight of your objectives. If the SIPP is intended to fund a large part of your retirement income, take plenty of advice from a professional who knows what he or she is talking about before going out on a limb. It’s important that your advisers are knowledgeable enough to advise you properly – particularly if tax questions are going to arise. Make sure you use a financial adviser with a good reputation and seek references where possible; he should direct you to a SIPP provider with the right expertise to meet your needs but here again it doesn’t do any harm to check out the firm’s record.   This ‘How to’ guide is produced by Shares Magazine and is only for general information and use, and is not intended to address particular requirements. The value of investments and the income derived from them can go down as well as up. Past performance is not necessarily a guide to future performance. You should get professional financial advice before making any investment decisions.