Insight: VCTs

Insight: VCTs

This year could prove to be pivotal for Venture Capital Trusts (VCTs). Although in circulation for more than 20 years, VCTs have become an area of increased focus in recent months. The sector raised £457.5m during the 2015/16 tax year – the third highest on record and the highest for 10 years. Tax relief arguably remains the most attractive feature, but the strong performance of VCTs – albeit with fairly substantial risk – is also something to take seriously.

The reductions in annual and lifetime pension limits introduced in April are unlikely to have driven substantial investment into VCTs, but the eyes of tax-hungry consumers are certainly wandering.

If you earn more than £210,000 pa, an annual pension contribution limit of £10,000 is unlikely to deliver a retirement lifestyle relative to working income. Given that most advisers suggest an optimum pension income of two-thirds salary or net profit, being restricted to tax-efficient payments of less than 5 per cent is not ideal.

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No tax liability

VCTs have an annual limit of £200,000, suffer no additional tax liability on dividends and growth, and are also free from capital gains tax – so the attraction is clear.

Although they share similar tax benefits, VCTs generally look to attract a more sophisticated audience than pensions, particularly because of risk.

At least 70 per cent of VCT investment must be qualifying, which is deemed as small companies with a maximum size of £15m that are unquoted or traded on the Alternative Investment Market (Aim) rather than other markets.

An example of this approach was witnessed in July as two of the most prominent VCTs purchased a 27 per cent stake in a cloud-based telephone systems provider. British Smaller Companies VCT plc and British Smaller Companies VCT2 plc invested £1.35m and £950,000, respectively, into Hosted Network Services – trading as Sipsynergy. This type of investment is crucial to younger businesses, and the benefits of any subsequent growth will be passed on to the VCT holders.

However, as newer companies often find it difficult to break into an already challenging marketplace, the possibility of failure is much greater. But on the other hand, this also presents the possibility for substantial returns as the data in Table 1 shows.

The top-performing fund over a five-year period, Albion Ventures LLP – Kings Arms Yard, has delivered £3,150 from an initial investment of £1,000, according to FE data. This was largely due to solid growth between 2011 and 2013.

In terms of holdings, the fund has a 32.5 per cent weighting towards the telecommunications, media and technology sector, with 17.8 per cent in renewable energy and 14.6 per cent in medical technology and life sciences.

Risk and return

Although highly successful over a five-year period, when analysing other data, the risk and volatility aspect of VCTs becomes apparent. A return of £1,552 over 10 years from an initial £1,000, although not disastrous, represents less than half the growth compared with that over five years.

The maxim “time makes money” is often proved to be true, but this is not always the case. Further analysis of the discrete data shows the fund has delivered positive returns in each of the last five years.

Possibly the most impressive performance in more recent years has been delivered by the Downing Protected Managers VCT Two. Launched in September 2008, it has achieved returns of 49.75 per cent and 45.91 per cent in the past two years – more than doubling the initial investment in less than three years.