Investors keen for slice of small business pie

Both have been a vital source of funding for smaller, growing companies that help to generate thousands of jobs and make a significant contribution to the UK economy. They have also added substantially to the coffers of HM Revenue and Customs (HMRC) in the process.

There’s plenty to suggest that investors remain hungry for VCTs and EIS. According to the Association of Investment Companies (AIC), the 2014-15 tax year raised £429m in new VCT shares. The latest figures from HMRC, meanwhile, show the amount of EIS funding increased by more than £500m over the 2013-14 tax year, reaching the £1.5bn mark.

Ongoing changes to pensions, such as the ‘freedoms’ announced last year, may have played a part in driving demand. The reductions to the annual and lifetime allowance limits, for instance, will only encourage people to look at other options that could complement their existing retirement plans.

As VCTs and EIS enter their third decade, we see investors increasingly using them to complement their existing investment portfolios Paul Latham, Octopus Investments

For clients prepared to accept the higher risks associated with smaller company investing, tax-efficient investments in VCTs and EIS represent a compelling opportunity.

But while demand for VCTs and EIS remains healthy, new data suggests supply is lagging. Figures from the AIC show VCTs raised around £150m between April 6 2015 and the end of January 2016, compared with around £165m in 2014-15.

There are several reasons for this. First, some of the largest VCT managers have been subdued in the market, perhaps choosing to keep their powder dry and find ways to deploy existing funds, rather than raising more money.

Second, the supply of underlying companies that qualify for VCT and EIS investment has been affected by the legislative changes announced during 2015.

For instance, there was the stipulation that funds raised by VCTs can no longer be used for company acquisitions to ensure continued compliance with EU rules on state aid.

Some VCTs have therefore needed to adjust their operating models – although it’s important to stress the tax benefits remain unchanged and the new rules don’t apply to investments already made.

Yet while some VCT providers are making changes, those whose investment mandates fit the new legislation have announced large fundraises to tie in with the tax year-end.

Advisers with clients looking to take advantage should encourage them to move quickly, as this will ensure they have the best chance of investing in their preferred choice of VCT.

As VCTs and EIS enter their third decade, we see investors increasingly using them to complement their existing investment portfolios and to take advantage of the tax incentives available.

It also seems that the government’s recent efforts have been successful in addressing tax avoidance, educating investors about government-approved schemes that are recognised as a vital source of funding to grow the UK economy.

What’s more, products are available from managers suitably aligned with the new rules – for the right clients, these products could represent an attractive option to be considered as part of retirement plans.

As long as they are comfortable with the risks, there’s no reason why clients shouldn’t consider VCTs and EIS as part of a well-balanced portfolio.

Paul Latham is managing director at Octopus Investments