InvestmentsMar 31 2014

Demand for VCTs sees an increase

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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.

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.

However, low liquidity is now becoming less of an issue. The more established Generalist VCTs have reached critical mass in terms of size and diversification of investments held such that they enjoy sufficient liquidity for active share buy-back programmes. The target discounts applied to share buy-backs have tightened with maturity and many target a range of between 5 and 10 per cent.

Clearly VCTs are not suitable for everybody and many investors with a cautious outlook will prefer to steer clear of backing smaller, often privately owned, young companies, which are inherently riskier.

VCTs are a higher risk investment due to the category of asset invested in and should only be considered by those wealthy enough to make them part of a wider investment portfolio and invest for a minimum of five years. Thus for those in that position, VCTs are becoming increasingly attractive as the industry comes of age.

Will Fraser-Allen is deputy managing partner, Albion Ventures