Teachable moments, offshore bonds & Swiss Banks

Posted on by FIRE v London

I caught up with a very successful friend of mine this week.  She sold a big chunk in her business a year ago, clearing >£10m of cash.  She has been meaning to decide what to do with the funds but has been too busy / fearful / etc to decide.  So the money has been sitting in cash in her bank account.  But she told me today that she’d decided to go with a Swiss Bank and use them to open an offshore bond, putting £5m into it.

I sighed, rolled my eyes, and generally acted in a not-very-empathetic manner.  Then I asked her to consider taking £1m of her £5m, doing a simple Do-It-Yourself approach instead, and comparing the difference over a few years.  She asked me to drop her an email with some details.  So today I sent her an email, which I reproduce below. Please note that this is not financial advice, just encouragement.

Any comments/improvements would be very welcome. For reference, Jane lives and works in the UK, has several kids, and has a husband who works in the public sector. Jane has a net worth of at least £20m.

To: Jane

From: FvL

As promised here is what I would encourage (note – not advise) you to consider as you deploy your funds.

Most importantly, make use of your annual ISA allowance.  Between you and your hubbie you can top up your ISA with about £30k this year (until 4/4/17!) and £40k next tax year. You can, between you, get £70k deployed by the end of next week.  If you open your account with iii.co.uk you could use iii to buy two ETFs (index funds, tradeable in real-time) as listed below.  Once the account is open and funded this would take about 2 minutes to do.

Secondly, you could try a ‘DIY/low fee’ approach for some of your funds and compare/contrast over the years with the high fee approach.  For instance rather than putting £5m into a high-fee place consider making this £4m only with £1m being used for the DIY/low-fee approach.

A simple and effective option for a DIY/low-fee approach would be to split between diversified liquid reputable ETFs (index funds, basically) covering both equities and bonds.  A cautious balance would be 50:50.  A more long-term, but riskier, balance would be 75:25.  For reference many experts would say you should have your age, as a percentage, in bonds.  So a 30 year old might have 70:30 equities:bonds, a 60 year old would have 40:60.  This is because bonds are less volatile and thus the chance of a calamitous drop are lower; as you near retirement you value certainty more.  I am pretty equities-friendly and I run at about 75:25 but given your lack of confidence you might decide that 50:50 would be a better starting point.

Vanguard and iShares (Blackrock) are the two largest providers.  For equities I would recommend a global mix, and would myself pick ticker VWRL (Vanguard World Equities).  For bonds most people would recommend a UK resident taking UK bonds, possibly even government bonds.  Personally I consider government bonds are very expensive right now so I would be tempted to go for corporate ones.  The iShares UK Corporate Bonds ETF (ticker SLXX) is a solid choice.

Some draft wording for your Swiss bank is below.

If you go ahead with this then I will buy you lunch/similar in 2020 if you promise to pull out your comparative performance between your bankers’ recommendation and the DIY/low-fee approach I’ve mentioned here.

Best wishes, etc

–

DRAFT NOTE TO SWISS BANK

To: Cordelius, Private Banker, Swiss Bank, London

From: Jane

Dear Cordelius

Thank you for your advice regarding my investment strategy.

You suggested I move £5m into an offshore bond.  I agree to use an offshore bond but want to invest only 80% of the sum we talked about, i.e. £4m.

For the remaining 20%, i.e. £1m, I want to deploy it at the same time but using a different approach.  I believe you can help me to do this.  What I am looking for is:

– an execution-only brokerage account.  One that will allow me to trade in equities, bonds and funds across the major exchanges – particularly in the UK and the USA (LSE, NYSE and NASDAQ).  Given your firm’s reputation I imagine this is straightforward.

– to put £1m into this brokerage account.

– to use this £1m to buy two holdings, as follows:

1. Vanguard Funds PLC VANGUARD FTSE ALL-WORLD UCITS ETF (LSE:VWRL, http://www.iii.co.uk/research/LSE:VWRL). This is the Vanguard ETF covering the FTSE All-World Equities index, with charges of 0.25% p.a..

2.  Ishares PLC ISHARES CRE £ CORP BD UCITS ETF GBP DIST (LSE:SLXX, http://www.iii.co.uk/research/LSE:SLXX).  This is the iShares UK Corporate Bond ETF, with charges of 0.20%.

– to have the two holding of equal in size, i.e. £500k of VWRL and £500k of SLXX.

– I want dividends/interest payments to accumulate in the account.  At this stage I plan to reinvest them every year, but will look to do so in a way that keeps my split between VWRL and SLXX at my initial split, i.e. 50:50.  So I’d prefer not to have automatic dividend reinvestment (e.g. ‘DRIP’, a Dividend Re Investment Plan) turned on.

– ideally I would look to spread my initial purchase over time (so-called “time cost averaging”), to reduce the risk that I buy £1m of stuff just before the market drops.  For instance ideally I would buy these positions in five equal portions every month for five months.  I.e. £100k of VWRL and £100k of SLXX every month, for five months. Can you help with this?

I can confirm that I am not looking for advice on this execution-only account and so will not be happy paying any form of discretionary/advisory service fee for it.  On this basis I would be grateful if you could confirm the annual account fee and the one-off trading fees for buying these two holdings.

Many thanks for your assistance in this matter.

Jane

37 thoughts on “Teachable moments, offshore bonds & Swiss Banks”

  1. Firstly many congratulations to you friend on such a successful career – no doubt the result of a huge amount of hard work and drive!

    Makes total sense, but why not suggest a 50/50 split between the Swiss Bank and DIY? I assume she is not confident enough to do that but then it would give a real clear year on year view, as opposed to “Well the Swiss bank paid 3 times as much in income!” (with the obvious response of yes, but you put 4x the amount in!)?

    I will be fascinated to see the response of the Bank….

    Also – what about the remainder £5M – please tell me this isn’t going to remain in cash for the long term?!

    She is also very lucky to have a friend like yourself to help steer her away from the potentially catastrophic error of putting all the money in a Swiss bank!

    Cheers,
    FiL

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    1. I don’t quite know what the rest of it has gone on. A large principal residence and a pied a terre have swallowed at least another £5m.

      You are right that she’d be better off with 50:50 or even 0:100 Swiss : DiY. But she’s quite invested in the decision. My argument doesn’t alter her core decision it just gives her a yardstick to learn for herself.

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      1. Fair play to her! Well at least it shows the thinking to go with DIY and see how it goes, maybe the slow understanding of it being better than a Swiss bank – but hopefully she keep it on track!

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    2. “Firstly many congratulations to you friend on such a successful career – no doubt the result of a huge amount of hard work and drive!”

      It always amazes me that people still cling to the false idea that being successful is a result of hard work and drive. There is no evidence that simply working hard and being driven make you rich and successful. There are far more people who are hard working and driven that will never be rich or financially successful. Becoming rich is about being lucky.

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      1. @AAJ _ agree there are far more people who are hard working/etc who are not rich/etc. However becoming rich if you are not hard working/driven is much harder and relies on luck much more. If you are hard working/driven and work on the right things you improve your chances dramatically. I recommend Malcolm Gladwell’s Outliers for some useful thinking on this subject.

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      2. @AAJ – as FvL says – if she had not worked hard then I seriously doubt she would be where she is now.
        Whilst there is with so many things always an element of luck in “right place at the right time” – you have to keep working hard and pushing and not being put off by any little setback.

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  2. Interesting and rather pleasant problem to have.

    I think when your net worth is up around £20m then ISAs aren’t really going to touch the sides of your tax planning. Utilising the full £40k for a decade you’ve only shielded 2%. So ISAs are actually of little importance here.

    I think the route would be to hire a good tax accountant/adviser (on a fixed fee basis) and make minimisation of overall costs inc. tax your overiding goal. That may well involve cheap ETFs but its not going to involve pensions or ISAs I would imagine as the limits are way too low to make the juice worth the squeeze as they say.

    In other words, I don’t think a standard UK DIY approach scales up well to ultra high net worth individuals

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    1. Very interesting point. Not one I quite agree with. My friend’s net worth includes a £5m-ish principal residence which Rich Dad Poor Dad would regard as a liability, not an asset. It includes, I reckon, over £5m of shares in her company which is now not under her control and may not ever materialise. It includes a pied a terre which is not earning any rent and so isn’t really an asset albeit it could be sold. I think her investable funds are quite a bit less than £10m. In that context she can reasonably aim for isas to end up with over 10pc of assets and well over 10pc of income. I agree that standard DiY isn’t scaling very well for her but it is still pertinent and prudent behaviour for her, no?

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      1. Ah, funny you should mention the primary residence, I meant to add that to my post. The tax treatment in the UK (no CGT) of your own home makes it an obvious avenue for tax mitigation. I would definitely buy a very expensive (but not necessarily a very large) home in her position, but probably no more than 1/3 of overall net worth. That would probably mean it has to be in London. Sounds like shes already done that so top marks!

        The pied a terre is then moot as shes already got a place in london (people only ever buy pied a terres in london right?)

        So as the remaining investable tends downwards from the £20m net worth, then for sure ISAs and pensions start becoming more attractive and can actually do some reasonable work for you.

        It would still be interesting to hear what a tax adviser who moves in those sort of circles would have to add. I’d imagine he/she would have *all-sorts* up their sleeve?

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      2. I’d argue that for someone in her position, minimising fees isn’t as important as minimising not only tax, but personal liability and accessibility of funds as well. You only need to get rich once — which she’s done — so now it’s time to protect the downside rather than chase the upside.

        When we’re talking about net worth north of £10m, I would think it’s worth looking at alternative structures like trusts, holding companies etc. in such a way that shelters your wealth a little more than merely holding it in investment accounts. Paying an extra half or one percent per year is often the price of doing this, but may well be a price worth paying if it means you can ensure the wealth lives on in your family for at least 3-4 generations without either being squandered by grandkids or great grandkids, or by losing it all in some sort of litigation or bankruptcy proceeding.

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  3. I’m unclear whether Jane or the Swiss bank would be putting together the £1m passive portfolio. If the latter, that’s crazy!

    As for the rest of the money, I’m surprised that Jane has amassed so much capital without having acquired much investing nous along the way. A single offshore bond implies significant concentration of counterparty risk, something that I would have thought she might wish to avoid. The same might be said for splitting the £1m between only two assets.

    I’d also be wary of the ‘low volatility equals low risk’ conflation. Bonds may be less volatile than equities, but that doesn’t make them lower-risk. Given where bonds’ pricing sits within the historic trading range, I see them as a highly risky asset class

    Were I lucky enough to be blessed with £5m to invest, I’d begin with an income allocation – a mix of perhaps 20 investment trusts collectively delivering a yield of around three percent, geographically and sectorally spread, and across several fund management groups. Thereafter, a growth portfolio – probably leveraged property, a few biotech and tech ITs and some provision for angel investing – and a defensive one (‘permabear’ funds set up to manage inter-generational family wealth). But first I’d want good tax advice, and to consider where best to reside, and be domiciled. That, rather than the services of the Swis bank, is where I’d be happy to pay fat fees for genuine expertise.

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  4. Not entirely on topic… If she’s been avoiding investing I wonder if she’s been making maximum jisa and pension contributions for her kids… If not then that might be sensible

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  6. Why not go to Vanguard direct as she has the min £100k required by Vanguard to qualify …no dealing commissions or platform fees…

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  7. Hi, your friend definitely needs to consult a Chartered Financial Planner to assist with wealth planning with a ten year plus horizon. She needs to put the maximum possible into a pension, she should ‘bed & ISA’ investments for both herself, her husband and each child every year going forward. She needs to open a SIPP for each child and pay in the maximum of £2,880 per annum. By having an offshore Bond she can help the children with University fee funding when the time comes by selling segments of the Bond each year so that tax is then paid at the young person’s marginal rate (i.e. 20%).

    With regards investing, encourage her to deploy funds passively as you suggest but maybe you could suggest a slightly more diversified passive strategy including Property REITS and some investment trusts? If she doesn’t want the hassle of monitoring/acquiring more skills in this area herself for a full DIY approach then she could go with a service like Scalable Capital where any adjustments to the portfolio are made on her behalf over time.

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  8. Oh, and show her all the comments you have received as this could convince her to take an alternative strategy than a Swiss Bank for wealth management!

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      1. My guess is there’s enough info here for her to recognise herself, so it could be a challenge. Unless you come out of the closet, of course!

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  9. I am surprised that you are implying that corporate bonds and government bonds take the same role in a portfolio. Probably the more important role of bonds is a portfolio balancer when the stock market turns ugly (ie they aren’t just for income when times are good). Government bonds perform this role in a way that corporate bonds don’t.

    The other consideration is that with such high net worth she can afford to take a bit more risk on the equity side so 50:50 seems over cautious.

    Everyone will have their own view but putting the money into Vanguard 80 Income fund with Vanguard or iii would be my suggestion.

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    1. I accept that government bonds are more textbook than corporate bonds. But is it really true that their performance is that difference? Would love to see evidence. And do you really trust UK government more than UK blue chips?
      Ideally I would have recommended an ‘all bonds (gilts + corporates)’ ETF but I don’t think there is one for the UK -would love to be corrected.
      Agreed that 50:50 is v conservative but given that she has had 100% in cash and professes complete ignorance/fear of the whole thing it is a simple starting point, and I did explain the ‘age = bond%’ rule so she might well decide to go <40% on bonds.
      Vanguard is a textbook solution too, I accept. But it doesn't open up the same doors to doing other trades etc which e.g. iii does and so is a bit less 'teachable'. If I can persuade her to give iii a go then she will persuade others who have <£100k to play with.

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  10. Here are a few quick references. None of them answer the question directly but they contain relevant information. My understanding from lots of self-study over the years is

    1) Correlations vary according to market conditions.
    2) When equity markets are tanking correlations with other asset classes often become closer (ie when you most need negative correlation you are least likely to get it)
    3) When the equities are suffering the best asset is definitely a government bond in your own currency
    4) The higher the yield on a corporate bond the more correlated it will be with equities in poor market conditions
    5) Separately there are arguments to avoid long-duration bonds.
    6) Separately there are strong argument to avoid Index linked gilt funds

    I follow William Bernstein’s advice which is to stick with ‘vanilla’ ie government bonds of short-medium term duration:

    http://www.efficientfrontier.com/ef/997/maturity.htm

    Some information on govt vs corporate bond correlations in these different papers

    Chapter 2 contains a nice correlation matrix between asset classes:

    http://marketrealist.com/2015/03/invest-fixed-income-diversification-income/

    There is a closer correlation between corporate bonds and equities than between government bonds and equities

    Paper from Vanguard – see figure 5 near the end

    Click to access why-own-bonds-when-yields-are-low-tlor.pdf

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    2. As I read that USA correlation matrix, the correlation (with S&P500) for Long Dated Corporate Bonds is lower (0.3, negative). Not much in it, basically. I agree that negative is better than positive for bonds but that is a second order effect isn’t it, relative to the yields / long term trends?

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  11. Index linked bonds have made stellar returns over the last few years. They are now priced to make negative returns under most plausible inflation scenarios. They have very long durations indeed and may not even provide the inflation protection investors might hope. (Any return from unexpected inflation likely to be cancelled by losses due to interest rate rises and the sensitivity long duration bonds have to interest rate rises. Finally a lot of the performance of the bonds has been driven by pension funds which are obliged to use them to match their very long-term liabilities. So my view is that private investors who are not so obliged and (depending on their age) may have a lower investment time horizon should avoid. Quite a bit of good stuff on Monevator blog on this.

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  13. No one appears to have asked the most basic question – what are her goals? What does she want to achieve with the rest of her life? Putting the cart before the horse makes no sense. You need a plan first, then look at how you employ your assets to achieve your goals. Otherwise you’re trying to find your way to a destination without a map.
    Not everyone needs a planner, but everyone needs a plan. A good firm of Certified Financial Planners will provide a comprehensive plan, and guidance on how to implement it if needed. Whether she’s just after initial help to get her started or a long term partnership with someone she would almost certainly benefit from taking some professional advice at this stage. Her Swiss bank definitely won’t be providing that service for her. Also, an offshore investment bond? Really?

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    1. I agree that to provide advice you would need to know her goals. But *given* that she is, after consulting a professional who will have asked about her goals, happy to have an offshore bond I am confident that a diy balanced portfolio will be a sensible alternative to put into the mix.

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      1. I agree a simple, passive diy portfolio is no problem as a solution once she has a plan (and assuming diy is what she wants). Past experience with Swiss banks tells me they are unlikely to look at lifelong cashflow forecasting or a ‘deep dive’ into goals in the way a CFP would. £10m sounds like a lot of money but you’d be surprised how often it’s not ‘enough’ if you have relatively expensive goals. The fact they appear to have suggested putting the entire amount in an OPB speaks volumes really. You’ve covered a lot of why that is in your comments below, which I’d agree with wholeheartedly. OPBs certainly can have a place as a tax efficient wrapper but highly unlikely to be the best solution for the whole lot. At the end of the day it’s only tax deferred – how will she utilise her CGT exemptions going forwards if all her capital is in the OPB? If she has another 50 years of life and assuming ISAs remain available, at levels applying from tomorrow – and assuming they never increase – that’s £1m she could gradually transfer from taxable to tax free – double that if she has a partner/spouse. There may of course also be scope to mop up unused annual allowances from past years and stick a reasonable slug in a pension – even if it was only £50k that’s still £50k which shouldn’t be going into an OPB.
        So many things she should be thinking about – and should be asking her Swiss banker about.

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    2. Why do you imply an offshore life bond is a bad idea? I took one out in 2012 after taking fixed protection on my pension (to preserve the £1.8mm LTA cap). With pension LTAs now at stupidly low levels now (£1m?) and ISAs totally negligible (2x £20k simply doesn’t make a dent in a £10m capital sum), then products like offshore bonds become much more important. The cost of around 40bp/annum isn’t nice to have to pay but it’s in line with many online broker’s platform charges. The advantages in terms of gross-roll up, the 5% tax free withdrawal, top-slicing relief, IHT protection, the ability to move units between family members etc make it something worth considering. Trusts or a family investment company may be a decent alternative or addition.

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      1. I am not saying that offshore bonds never have a place and I agree that they scale better than eg ISAs.

        However in my experience the people who sell such bonds are fee motivated not expenses / return motivated. And my friend didn’t know the fees or the underlying holdings so I will lay odds that in effect she has got multiple layers of high fees.

        On top of that such bonds have other issues
        – the fees can be set on initial investment and not aum so you can find yourself with very high percentage fees after steep downturns. I speak from experience.
        – assuming £5m is the majority of her liquid assets then she is surrendering a lot of liquidity.
        – you still need a plan for where to put the 5pc a year you take out.
        – all gains, capital or otherwise, are taxed as income above 100 pc. With such a large bond she is likely to pay higher rate tax on a significant slug of this.

        I agree that the family member thing is useful and is a reason she has gone for this.

        My point that maxing out ISAs is sensible is true for anybody who can (isn’t it?), even if it doesn’t dent £10m very much. It is a bad sign that her Swiss friends didn’t point this out; I feel looking for such advice is a sensible screener for the quality of financial ‘advice ‘.

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  14. I would disagree with the proposal on one minor point : it is not tax efficient to have a separate corporate bond fund, assuming she is UK domiciled. Slightly better to have a fund containing a mix of equity and corporate bonds. Income from a corporate bond fund is taxed higher than dividends from a mixed fund.

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  15. Very interesting to see a glimpse into the wealth preservation and tax planning strategies that needs to be considered when isa’s and pensions barely touch the sides. As others have said an intriguing but rather nice problem to have!

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  18. Hi

    Just picking up on this old post as it’s still really useful. I’m in a similar situation to your friend, and a swiss bank is suggesting an offshore bond (for a much lower proportion of my portfolio) – so I found your analysis of the downsides really helpful for the discussion I’m due to have.

    In case others scour these old posts as I do for useful info, I would also suggest that your friend takes our Joint Life Second Death insurance to cover inheritance tax in case both adults were to die suddenly. Even just to cover a 10 year period while other tax planning is put in place. It may reduce some of the reason for the scale of the offshore bond. My understanding is that, subject to health, at age around 50 one should expect to pay c,£10k per year per £1m that would cover the IHT. i.e. on £20m net worth, may pay quite a lot, but in the meantime don’t need to get tied up in trusts and other vehicles.

    For what it’s worth I’ve time averaged my proceeds through Interactive Brokers into VWRL (66%) and VGOV, IGLH, GILI for bonds – which I really don’t understand, but figure I’ve got 5-6 years of living expenses in bonds. I’ve kept enough in cash to pay my big tax bill.

    I’ve been maxing out JISA, JSIPP contributions for the last few years anyway and will continue to do so, noting the opportunity for 16 yr old to have a JISA and a cash ISA until they are 18 allowing for a few years of accelerated contributions.

    I thought the comment from The Rhino re CGT treatment on primary residences was really useful – is this a good time to make a big bet on London property though. Certainly something I’m thinking about.

    So far (6 months since windfall) I’ve avoided doing anything that permanently changes the treatment of any of the money – trusts, offshore bonds, holding companies, because my understanding is that once it’s done it’s hard/expensive to unravel.

    Thanks for this fantastic blog – the articles and the comments are a gold mine.

    John

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