VCT rule changes to impact dividend stream

The government introduced a raft of changes in 2015, which included capping the age of firms and stopping businesses from using VCT money to fund buyouts and acquisitions. 

According to David Hall, managing director of YFM Equity Partners, three quarters of the VCT money had been invested in ownership changes prior to 2015.

These types of investments, he said, had fuelled the growth and consistent dividends as new people came in to invigorate businesses.

With the rule changes of 2015 now starting to be felt, investors might have to get used to a slightly different picture going forward.Ben Yearsley

Speaking during a roundtable hosted by the Association of Investment Companies, Mr Hall said: “2016 and beyond is a different beast.

“In terms of the types of businesses, we are looking for firms with significant growth,” he said, pointing out that a lot of these are tech businesses which have a higher volatility of return compared to the ownership change firms.

The YFM boss warned that trusts are already seeing the impact and expect a higher volatility of return in the future, as opposed to the consistent dividend seen previously. 

“Historically, we used to diversify away that risk for investors, but the discussion we are now having more with IFAs is there is more onus on the investors to diversify their risk.” 

Mr Hall explained this by pointing out there is now a greater range of outcomes from the assets VCTs hold, with greater volatility when some investments fail.

VCTs cannot diversify this risk away unless they significantly increase their scale, although he said this was difficult to do quickly and maintain quality. 

One way to cope with this higher volatility, he said, is to invest in several different VCTs to diversify risk.

“Advisers have to advise clients to put a little bit less into a VCT but across a number of different VCTs to try to spread the risk and get a smoother dividend stream.”

“The managers are much less capable of [diversifying that risk] now because of the quantum of cash they are dealing with,” he said, denying however this makes VCTs less attractive investments.

“The challenge for the IFAs will always be that this part of the portfolio will always be a relatively small part of a clients’ overall investments,” Mr Hall said.

Yet Mr Hall admitted this has added some pressure in terms of the market ensuring there is a way to look at all the VCTs in a batch so IFAs can get a view of which ones to invest in.

Patrick Reeve, managing partner at Albion Ventures, echoed Mr Hall's points, adding VCTs give investors access to an asset class they wouldn’t be able to otherwise.

He therefore said it was unlikely the increased volatility of return could make VCTs less attractive.

“There really isn’t any other way of getting access to these very small companies without going direct, which is very tricky.”

Ben Yearsley, investment director at the Wealth Club, said: “Tax-free dividends remain the most attractive feature of VCTs and the last decade has shown both excellent total dividends and, more importantly, consistency in those dividend payments. 

“With the rule changes of 2015 now starting to be felt, investors might have to get used to a slightly different picture going forward.”

He said the emphasis on early-stage, higher growth companies should lead to equal if not higher returns in the long run. 

However, Mr Yearsley warned that while the last decade has been characterised by consistency, the next decade will see bumpier returns as dividends will have to be funded more from sales of businesses rather than maturing loan stock for example. 

“From an adviser perspective, they should always have been responsible for ensuring clients had a mix of different styles and types of VCT,” he said.

“Performance will naturally vary year by year, but hopefully by focusing on the best resourced managers and investing for the long term, shorter term performance dips from some will be matched by higher performance from others.”

katherine.denham@ft.com