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Guide to Venture Capital TrustsPros and cons of VCTs for investors
Given that it is easier for a smaller company to double or treble in size compared to, say, a larger FTSE 100 company, the potential returns to investors available through this area of the market are significantly higher in the long-term.
The tax benefits are also clearly a big benefit for investors.
According to Michael Piddock, business line manager for VCTs at Octopus Investments, the income tax relief acts as a buffer against the risk of some of the companies in your VCT portfolio falling in value.
He adds that the income tax relief could also be viewed as an “instant return” on your investment, given that an investor will receive 30 pence back for every £1 they invest before the fund has achieved anything.
Add onto this the fact that both growth and dividend income are tax-free and the overall return profile for the investment becomes increasingly attractive versus other investments that are taxed, Mr Piddock notes.
Of course, the risk is that the investments drop substantially in value. Many VCTs have struggled with performance over the years, especially those in the ‘specialist’ sectors.
Mr Piddock said investors need to recognise that investing in smaller companies inherently carries a higher level of risk than investing in larger, more established companies.
“VCTs that invest in early-stage companies will expect a certain proportion of the companies in their portfolio to fail, while even ‘bigger small companies’ listed on Aim will often be affected by market fluctuations outside of their control.
“VCT managers are experienced active investors in this area of the market and look to minimise these risks by good company selection and diversifying investment risk across the portfolio, often of between 20 to 30 companies.”
Jemma Jackson, PR manager of the Association of Investment Companies, points out that the value of the underlying investments of a VCT can be uncertain, as they are often unquoted investments that do not have a readily available market price.
She also warns VCTs generally have higher running costs than other investment companies and like many other collective investments most charge performance fees.
VCTs have also often been seen to have poor liquidity as a result of investing in smaller often unquoted companies.
This year Mr Piddock noted a number of managers have committed to buying back shares at a 5 per cent discount to their net asset value, creating improved liquidity and an opportunity for investors to sell if needed.
The nature of buy-backs is being looked at by the government, which is keen to prevent investors selling shares back to the fund after their five-year qualifying period has expired, only to buy back into the fund to enjoy another round of tax relief.
A treasury review into so-called ‘enhanced buy-backs’ is underway, with responses due by 26 September 2013. Any new rules would come into effect in April 2014.
