Demand for VCTs sees an increase

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Tax-efficient investing - March 2014

Latest figures from the Association of Investment Companies (AIC) show that assets under management for the sector reached an all-time high of £2.9bn as at January 5 2014 and fundraising from April 6 2013 to December 31 2013 was £152m, up 69 per cent on the same period the previous year.

This growth is driven by demand from both existing and new investors. According to a recent survey conducted among financial advisers, an estimated 16 per cent of clients will be investing in VCTs for the first time, driven by a number of factors including their ability to generate tax-free dividends, maxed-out Isa contributions and the new reduced limits on pension contributions.

The increased popularity of VCTs has been achieved in spite of some deep-seated perceptions that they are unduly risky, charge unreasonably high management fees, have opaque management structures and low, if not nonexistent liquidity.

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These criticisms have been around for many years – after all VCTs were established nearly 20 years ago in 1995 – so to what extent are they valid?

The VCT market is now mature and includes a broad range of products and providers. Some investors and their advisers have found it challenging to put VCT performance in context given that while VCTs are high risk they can still deliver decent returns with a balanced Generalist investment strategy.

The performance tables for VCTs in general do show a mixed record. However further analysis shows that the industry has consolidated in the past few years. According to the AIC, 74 per cent of the assets invested in VCTs are now under the management of the 10 largest managers.

A number of these managers are now well established and their Generalist VCTs provide decent performance and importantly predictable tax-free income.

The performance of VCTs is further enhanced by the very generous tax breaks enjoyed if held for the requisite five years.

Turning to VCTs charging unreasonably fees, it is fair to say that fees are higher than some other investment vehicles such as Oeics, unit trusts or mainstream investment trusts. Typically, VCTs have total expense ratios of roughly 3 per cent, including a management fee of between 1.75 and 2.5 per cent. But these higher costs should be viewed in terms of value rather than pure cost. These higher fees are the entry price for many investors into a completely new asset class and reflect the effort and due diligence required to identify the underlying small companies, then managing them.

Each VCT might invest in up to 30 smaller companies with very significant VCT manager involvement with those companies, providing strategic guidance and full participation at board level. This goes way beyond anything undertaken by traditional equity focused investment trusts or Oeics.

The perception of VCTs as opaque is also worth debunking.

Traditional investment trusts seem to be spared this criticism, yet VCTs work to the same high level of corporate governance and reporting. VCTs produce annual/half-yearly reports, quarterly interim management statements and appoint independent boards to monitor the performance of the VCT manager.

The criticism that VCTs suffer from low liquidity and large discounts has been reasonable in the past. VCT shares traded at relatively large discounts to their underlying net asset value because of a lack of a secondary market and active buy-back policies.