Octopus Inheritance Tax Service

Shares in many unquoted trading companies qualify for Business Property Relief (BPR), which after two years fall outside of an investor’s estate for inheritance tax purposes. Many businesses qualify, including those that lend money; businesses lending money for property deals form the backbone of the Octopus Inheritance Tax Service (ITS). Investors in the Octopus service buy into an unquoted company, Fern Trading Limited. 

Highlights

  • Capital preservation or growth option
  • Target return of 3% per annum
  • Asset-backed lending
  • Solar farms 

Video interview


The manager

Octopus Investments is the manager. It launched in 2000 as a VCT manager and has since branched out to include EIS, IHT and more mainstream funds. Octopus now manage assets of £5.7 billion of which £3.6 billion is in unquoted investments. There are 161 investment professionals within Octopus Investments across their energy, healthcare, property finance, ventures and general investment teams. Paul Latham, one of Octopus’s senior directors is integral to this service.

Target return and strategy

The target return is 3% per annum net of all fees. Octopus’s annual management fee is rolled up and not paid until investors cash in and have received a minimum of 3% compound per annum return.

Investors buy into a large unquoted trading company called Fern Trading Limited. Fern’s CEO is Paul Latham, and the majority of the activities of Fern are conducted by Octopus employees.

Fern Trading has several main parts to the business. About 60% of the underlying investment is exposed to energy related businesses; approximately 35% is a property lending business (called Dragonfly) and the balance is held as cash.

The energy related businesses are mostly concentrated around renewable energy generation and development of these projects. For example, Fern lends money to solar energy parks that require short term bridging loans. These loans are used to get the solar park to the point that it is connected to the grid. At this point, the solar park refinances and the loan is repaid. Often Fern lends money to solar parks being funded by other Octopus managed products. 

As well as development finance, Fern also owns solar parks and other renewable energy projects that are up and running, generating electricity and earning income (from the sale of this electricity). Biomass sites, landfill gas projects and wind farms are also owned by Fern. On the energy side, Fern has moved more towards the generation of energy as it is more predictable than the development projects. Many of the energy projects sell the electricity generated on long term purchasing power agreements. 

Dragonfly, Fern’s lending business, is a commercial business looking to lend money primarily to property developers. There is a maximum loan to value ratio of 70%, though this figure is typically closer to 60% (Octopus use in-house as well as external valuations). The typical loan is for six months and with an annualised interest rate of 10%-12%. The biggest loan has been for £13 million and the smallest is typically £0.5 million. However, a £1 million loan lent against a £2 million property value is the typical deal. Capital preservation is important, therefore lending against bricks and mortar is vital.

To deliver a 3% return to investors, Fern Trading needs to deliver a gross return of approximately 10% across the book of investments. This seems high, however Octopus receive 4.8% plus VAT, the tax man receives about 1% of this figure in corporation tax (Fern paid £8.8m in corporation tax in the previous financial year on profits of c.£41.5 million) and there is the cash drag effect of not having all the money invested all of the time. Octopus believe that a 10% gross return can be achieved without undue risk.

Fern Trading has three directors, two of whom are independent of Octopus. Fern’s board annually reviews the fees paid to Octopus to cover the running costs.

Performance

Below is a graph showing the monthly share price for Fern Trading Limited (30 April 2010-29 February 2016). 

Fern Trading Limited Share Price Performance

Fern Trading Limited Share Price Performance

Risks

With any unquoted investment the key risk is liquidity and not being able to dispose of your holding when desired. Octopus has two buffers against this. Firstly, a large part of the investments are short term loans to property owners, often for periods of under one year; this has the added benefit of ensuring that if interest rates do rise, the underlying investments aren’t locked in to lower rates. Secondly, there is also between 5%-10% held of the net asset value of Fern as cash. However, if the whole portfolio needed to be liquidated in a very short period of time, it couldn’t. Another risk is that the monthly share price is set by Fern’s directors and will not necessarily have a direct correlation to the underlying net asset value of Fern. They are valuing the business on a going concern basis, not on day to day cash flow. 

Fees

There are two layers of fees on the Octopus ITS. At a product level, Octopus charge 1% plus VAT per annum. Octopus roll this up and only receive it upon client encashment as long as the investor has received 3% per annum compound growth. In addition to this, the underlying investment, Fern Trading Limited also has costs associated with running the business. The majority of Fern’s staff work directly for Octopus. Fern Trading pay Octopus 2.5% plus VAT per year to run the business – in the last financial year Octopus received £48 million from Fern. Fern’s directors annually review the level of this payment, and Octopus Investments will make a profit on it. There is no performance fee as the focus is on predictability of returns not on excessive returns. 

Summary

Octopus is the market leader in inheritance tax investments. This service has consistently delivered upon its aim of providing liquidity to investors and delivering 3% per annum growth. This consistency has led the Octopus service to acquire assets of £1.3 billion. The mix of short term loans with renewable assets provides an interesting mix of long term stability and short term higher return deals. The downside of the Octopus service is the cost; 1% seems fair value at the product level but Octopus also receives 3.8% to run Fern on a day to day basis. Investors need to decide if they are getting value for money.  Information at at March 2016.

The details

Type
unquoted
Min. Investment
£25,000
ISA Available?
No

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