Italy: Crowded Out

Steve Johnson

Italy has been a wonderful hunting ground for the Forager International Shares Fund since inception in 2013, especially among smaller companies where we most often find an edge. The country has many world-class businesses and they have been cheap, until recently.

Over the past six months, though, stock prices are up dramatically. That’s been good for our existing portfolio but terrible news on balance. Today’s bargains make tomorrow’s returns.

Foie gras finance, such as the ECB’s €60bn a month of quantitative easing in Europe, is surely playing a part. But we suspect it’s a change to tax and investment laws that is doing the most to price us out.

Tax incentive

At the start of 2017, a new law allowed Italian fund managers to establish individual savings plans called individuali di risparmio (PIRs). Big tax savings await individuals invested in such funds who hold for five years or more. Specifically, zero income tax and zero capital gains tax. Individuals can invest €30,000 a year, up to an aggregate of €150,000.

Italy is a high tax country. And its residents love a tax loophole even more than Australians. This measure might be enough to get the populace over its historical aversion to sharemarket investing. Assets within the PIR also avoid inheritance tax, another bugbear of Italians.

To comply, PIRs must have at least 70% of assets invested domestically, in Italian company equity or debt. Furthermore, Italian small and mid-capitalisation equity and debt must comprise at least 21% of total fund assets. It’s that last rule that hurts us most.

Flows into PIRs in recent months have swamped the initial estimates made by the Ministero dell’Economia (Ministry of Economy), which will surprise nobody but the Ministero dell’Economia. Updated forecasts now suggest inflows over the next five years into smaller and mid cap stocks alone might top €10bn. Even that might prove conservative as asset managers rush to set up PIR-compliant funds. Considering the free float in that part of the market is less than €50bn today, the potential for distortion is significant.

There are still opportunities to buy cyclical Italian businesses at very attractive prices and two of our newer investments are in the country. But the days of paying less than 10 times earnings for high quality growth stocks look to be behind us.

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