The GREAT Tax Credit Divide 2015

The proposed reduction in tax credits which are to reportedly negatively affect close to 3 million families has set off an incredible commotion as the House of Lords rejected the controversial cuts planned by the current Conservative government earlier this evening. The tax credit reform is part of a wider reform of the UK’s welfare system coinciding with the introduction of Universal Credit which seeks to simplify the welfare system by consolidating a number of benefits.

However, reforming the actual administration can only go so far in making efficiency savings until serious cuts need to be made to welfare payments directly. In fact, public spending is being cut everywhere, defence, healthcare, education, the police and pensions. The reason for these cuts is principally because of the current government’s approach to the economy, which is effectively balancing the books, that is to only spend what you earn. Bear in mind the UK debt currently stands at over £1.5 trillion and it is growing, we haven’t even been able to chip away at that amount yet and it’s unlikely that we will be able to chip into it until we run a budget surplus; that is earn more in revenues than what we spend.

The debate between the Osbonites and the Corbynites revolves around how to essentially get the UK economy back into the budgetary surplus in order to begin to reduce the debt. Now, as the UK debt is close to 90% of current GDP, we could be debt free in a little less than a year if we literally stopped funding absolutely everything; that’s no police, no welfare, no healthcare, no pension payments etc., whilst we continued to pay our taxes and maintain our current spending patterns. Obviously that’s not going to happen and even if it did the anarchical effects which would probably resemble a cross between The Purge and The Great Depression of essentially no government would outweigh the price of the current debt probably many times over.

So more reasonable economic solutions actually stem from two salient economic theories that have survived the last couple hundred years or so, that is free market capitalism as advocated for by the likes of Adam Smith and Milton Friedman and a planned economic system as advocated by the likes of Karl Marx and Maynard Keynes. Though these days we actually live in a mixed economic system it is important to be aware of some key principles that could be seen as the driving force behind taxation and welfare policies.

A free market approach tends to want less regulation over everything including working conditions, the minimum working age and the minimum wage as it is more concerned about the supply side of labour, that is reducing the friction that employers have to face when deciding who to employ. Now contrast this, with the current government policies towards the unions, tube drivers, the NHS and more recently medical doctors who are facing pay cuts or a challenge to their influence over employee labour conditions. You can also argue that increases in the national minimum wage whilst appearing to be against free market principles can actually complement it when you remove the apparent cushion of tax credits, thus encouraging more parents to commit to longer hours of work whilst employers actually get a concession in their corporation tax to assist in paying for the increased wages.

But would a planned economic approach be any better? In the aforementioned situation you are essentially tightening the country’s belt, something which has come to be known as ‘austerity’, but you are dealing with the problem of government debt head on. Or are you? Especially considering the cost of white collar crime at £60 billion a year with a detection rate of only 5% coupled with billions in lost tax revenues by corporate powerhouses such as Google, Amazon and others for not paying their portion of UK tax. It can appear the poorest and the least powerful are to pick up the burden of UK debt. Sadly, we live within an economic system that relies on foreign investment that creates jobs and in turn income tax that the government would not have had otherwise and thus the reason why the government has always turned a blind eye towards tax avoidance until it became a public moral issue following investigative journalism.

So, yes, back to whether a planned economy could be any better. According to Keynesian economists, the government actually needs to spend more to create more jobs and encourage greater private sector investment and increasing exports which would yield greater returns over the medium to long term. This is actually referred to as Aggregate Demand, that is the demand for the gross domestic product of a country and there’s actually a really fancy formula which goes something like AD = C + I + G + (X-M)…forgive me if I don’t explain it in this piece but note it’s not scientific no matter how much it may look like it is.

Look at it as if you were to take out a business loan in order to kick start a business and when the business is in profit it would start to repay the loan. This is effectively what the Corbynites advocate, potentially sweeter times now funded by debt with the hope that any national investments work itself out.

So what is the right way forward? At the time of writing this piece, I truly don’t know, my mind often sways between two extremes and I simply don’t have enough policy information to make a judgement. What I do know is that we must put a truer value on the economic cost of our policies, for instance, if we were to take away tax credits and force parents to work more hours, or where they literally cannot work more hours have only to cut back on heating and food for themselves and their children what would be the human cost be it psychologically and socially that would affect our communities in years to come as our societies which are already challenged with serious mental health crises navigate themselves into adulthood and then parenthood.

Shaping finance through shariah: a layman’s observation

Faith and finance could not be any more dichotomous today, yet the UK is the leading western country and Europe’s premier centre for Islamic finance with US$19 BLN of reported assets.

London lawyers have evolved skills and experience to become well versed in shariah compliant contract law as well as financial instruments in order to service the growing appetite for shariah compliant investments from Middle Eastern investors who believe the UK to be a judicious and profitable place for investment; our accountancy and banking sectors have similarly adapted to this growing and profitable emerging market. Couple this with the need for foreign investment into the UK’s major national infrastructure projects for the next 20 years we can be certain that because of our national economic interests, the UK offers a profitable and most importantly a potentially halal enterprise for our market evolving a service provision for the religiously conscious wealthy foreign investor.

However, ironically, Islamic finance has yet to take off amongst the UK’s 2.7 million Muslims and this is largely due to the fact that UK consumers approach Islamic finance as a debtor whereas foreign consumers tend to be creditors or investors. This has a significant impact on how you relate to the current modus operandi and structure of Islamic finance. For instance as a creditor, be you a stock and shares investor or a current account holder, you can be confident that your money is invested in a shariah complaint manner which is similar to conventional ethical funds that screen investments to ensure your monies are not invested in what are known as vice investments e.g. funds that invest alcohol, tobacco, munitions, gambling etc related stock. Furthermore, for investors in shariah compliant funds, there are added considerations to ensure where interest cannot be ignored that interest is siphoned off and donated to charitable causes. Another interesting criterion for shariah compliant funds is that they will not include companies which generally carry more than 30% debt.

So to summarise the three key principles for shariah compliance are 1. There should be no interest or riba which means an increase on the capital 2. Not investing in vice funds and 3. Not investing in companies that are in significant debt. However, all these principles are secondary to the fundamentals of ideal human conduct which should be based on equity and mercy.  

Our global political system has become incredibly connected through the membership of a whole host of international organisations be it the World Trade Organisation or the becoming of federal alliances like the EU and also cooperative alliances between a select group of countries such as the G7. Naturally, the world utilises the banking systems of nation states which when enters into the arena of international trade they are also governed by what is known as the Basel Accords which proffer guidance to regulate the global banking industry.

The implication of a well-connected economic system tends to create fluidity in markets meaning fewer barriers in the movement of people, products and services in order to encourage economic prosperity meaning more jobs, innovation and entrepreneurship. However, for the sake of ‘economic prosperity’ we seek to encourage the deregulation of markets, create and loan money that literally does not exist and then are legally allowed pursue the debtor. As we have deregulated markets we have unwittingly ‘deregulated ethics’ allowing companies to freely promote a culture not based on moral values but one based on maximising our consumption, at the lowest possible cost, at the highest margins with total disregard for the net societal interest.

As we have mastered the exploitation of our own markets our businesses encroach on politically weak and less technologically sophisticated cultures and communities, where the goal is rarely philanthropic but rather to open markets for the purpose of profit regardless of the consequence on the host society.

Therefore, in an age of profit and a failure of theology of sorts, Islam has begun to offer a strong alternative to the conventional approach to profit and investment. Having proven its resilience before and after the global crisis in 2008, as evidenced by the IMF, the future for shariah inspired principles for the growing socially conscious investor and the risk mitigating fund manager who opt to invest in shariah compliant funds will offer a powerful economic challenge to riskier vice enterprises that although may be profitable on the balance sheet remain incredibly costly to our societies. 

How is your money invested? An insight into Discretionary Investment Management and Model Portfolios

Investors can get confused with the nature of investments that they have been recommended by their financial adviser. No doubt they would have been told about the pertinent points of their investments such as charges, taxation and exposure to risk but it is important to also understand the comparative cost of what is being offered and what you can probably get elsewhere. What’s more in an ever evolving technological landscape you should also be thinking about how your provider has made use of those web based interfaces to make your investment experience that much more wholesome and inviting.

It’s easy to be intimidated by jargon and an articulate professional, but in truth there is really no substitute for logic and common sense. Investors should be confident that they understand the services being offered and in that regard ask the questions that appear to sound stupid and not be afraid to seek justification for claims being made. Simply asking, ‘How? What? Why?’ can go a long way in testing the competency of any professional consultant.

One such area where confusion can exist is the different approaches to fund management and the costs associated with the respective approaches. There are however two areas that would be useful to understand and they are referred to as Discretionary Investment Management (DIM) or as its old moniker Discretionary Fund Management (DFM) and since 2012 the rise of Model Portfolios; but in order to understand them both we need some historical context.

Since 2012, the financial services industry has changed radically following the implementation of what was known as the Retail Distribution Review or RDR, and it is generally agreed for the better, especially in relation to improving the competency of financial advisers, the transparency in costs and the investment management service itself.

In the past advisers retained the responsibility for fund selection and asset allocation and would require consent to make changes to the overall portfolio. This was known as an ‘advisory portfolio’; this ‘advisory portfolio’ included a form of fund management services, although, within the ‘advisory portfolio’ it was limited to the particular fund that particular fund manager was in charge of. So there would essentially be multiple fund managers, all working independently of each other, contributing to the performance of the wider portfolio which had the oversight of the financial adviser.

Also during this period a premium service existed that could manage a client’s entire investment portfolio day to day  and that particular service offering was provided by a DFM who would construct a portfolio based on the client’s attitude to risk and investment strategy i.e. particular ethical considerations or interest in niche investment areas which would all be explored by the adviser. 

However, the DFM would not need to seek consent from the client to make decisions to alter the holdings in order to respond to market changes, which was crucial in reducing risk and maximising market opportunities. Now the privilege of having a DFM to manage your investments would often require several hundred thousands of pounds to invest due to the associated costs of research and day to day investment management, thus this being of benefit to the few with the rest having to rely on the more accessible and cheaper ‘advisory portfolios’.

Now fast forward to today and the investment universe has evolved, with contributory influences coming from I.T and now DIM service providers. The I.T industry has recognised that they can provide an interface between fund management and the client and the DIMs have thought about ways to implement solutions for both advisers having to deal with the change in the regulatory landscape mandating better investment management for their clients but also recognising a market opportunity to service clients with less than the several hundred thousand to invest.

This has led to the development of model portfolios which comprise of a bespoke mix of investments for a number of different risk profiles. The adviser concludes which model would be suitable for you and invests your monies into that portfolio. On the face of it, it appears similar to what DFMs end up doing i.e. managing your monies in line with the parameters given by your adviser but crucially I.T plays a significant part in ensuring a model portfolio retains its integrity throughout the year via periodic rebalancing. This means that based on market movements, a particular asset class may become disproportionately represented due to its increase or decrease in value thereby affecting the risk vs reward balance. In order to mitigate an adverse exposure to risk, units or shares are automatically sold to return the portfolio to its initial position.

Whereas with a discretionary investment management service you have a specific investment team looking after your portfolio day to day, with a model portfolio, you still have access to those specialist fund managers focusing on their respective areas independently but I.T plays a crucial role in ensuring your portfolio is not exposed to too much risk or maintaining levels to encourage efficient rewards.

It is for this reason, model portfolios tend to be considerably cheaper than DIM services and for the majority of investors where a bespoke investment strategy guided by the client is not required, it offers a sensible solution to meet their needs.