VCT capacity crunch as pension tax changes bite

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VCT capacity crunch as pension tax changes bite
Funds raised by VCTs (excluding buybacks)

A pensions-related rush in demand for venture capital trusts (VCTs), coupled with regulations that have constrained their capacity to invest, has cast doubt on the sector’s ability to last the Isa season.

Cuts to the pensions lifetime and annual allowances, as well as more onerous taxation of dividends, have prompted savers to seek other kinds of tax-efficient investments in recent years. Interest in VCTs, which normally picks up in the final weeks of the tax year, has proved much more frenetic in 2017. Seven of the 19 vehicles open to investment have already reached capacity, with more expected to follow in the coming weeks.

Meanwhile, European rules that prohibit VCTs from recycling funds into management buyout (MBO) and replacement capital deals have hobbled the industry’s ability to deploy capital.

“The new pension limit has come in, which means high-net-worth (HNW) investors are looking for pension alternatives,” said Ben Yearsley, investment director at the Wealth Club. “But the supply side has a lack of products. The rule changes that banned MBOs led to a massive supply shortage.”

Enterprise Investment Schemes (EIS) are facing similar constraints, as rule changes mean that energy-focused EIS, which accounted for 50 per cent of the market in the previous tax year, are no longer available.

Fundraising targets reflect the current supply issues. The VCT sector is looking to raise £389m this year – down from the £458m mustered in 2015/16 – and had raised £253m as of February 10, up from £184m a year earlier, according to the Association of Investment Companies (AIC).

“VCTs could raise more money, but it’s a question of being able to deploy that money in the shareholders’ interests,” said Dan Kiernan, research director at Intelligent Partnership. “If they raise funds and can’t deploy them, their performance would suffer in the long run.

“Investing in smaller companies is difficult and it’s hard work, particularly if they are unquoted companies. Most of the VCTs also take an ongoing role with their investees, so there’s an issue of capacity to do that kind of work. You can’t just magic up another £20m or £30m of investment and look after that.”

The sector has been gaining traction over time. According to AIC data, VCTs raised more than £400m in funds for each of the past three tax years. But much of this money tends to come in right at the end of the tax year – a tactic that is unlikely to prove wise this time around.

“[This year] it’s a good strategy not to leave it to the last minute,” said AIC communications director Annabel Brodie-Smith.

With less scope for pension investments, dwindling VCT capacity could pose difficulties for those with clients seeking tax-efficient options. However, there is some hope that the crunch could bring about positive changes.

Mr Yearsley predicted that heightened levels of demand could see VCTs morph into an “all-year product”, making both fundraising and investing easier. He also suggested that increased investor interest in the VCT sector – which has not seen a fresh generalist launch for some years – could attract new players into the market.

Others, such as Mr Kiernan, believe the opposite could happen, leading to a less attractive marketplace for investors.

“There are quite high barriers to entry,” he said. “It’s much more attractive to invest in an established VCT that already has a portfolio and is already paying a dividend.

“The power is very much in the hands of the managers. There aren’t any pressures on them to reduce their costs or increase transparency. 

“It would be a very good thing to have new players, but this [demand] may have the opposite effect.”