As we approach the end of the UK tax year, investors who have exhausted their pension and ISA allowances are casting around for other tax efficient investment vehicles. One popular option in the past has been venture capital trusts, or VCTs. These are funds listed on the London Stock Exchange which invest in early stage, high growth companies, including companies listed on the AIM exchange.
The big issue with the VCT industry at the moment has been a change in the tax rules, announced in 2015, but only now making themselves felt in the market. In July 2015 the UK government announced significant changes to the tax regimes governing venture capital trusts. In particular the rules, which were partly driven by EU requirements, impacted the way VCT funds specialising in management buy-outs would be affected.
Other changes include restrictions on how old a company can be to receive investment – most of them now have a seven year limit, although ‘knowledge intensive’ companies have a 10 year maximum age. There is also a cap now on the maximum amount of money these companies can receive from VCTs and other tax-efficient UK-based funds.
With the successive cuts to pension allowances, many individuals in the UK are either finding themselves being limited by the £1 million lifetime pensions allowance or the annual £40,000 pension contribution limit.
“This is a market where as much as half of the money is raised in the last two weeks of the tax year,” explains Richard Hoskins at Kin Capital.
As the end of the tax year approaches, most VCT offers have already closed. Hoskins expects the demand / supply imbalance to change over time, as managers change their investment strategy, but this is easier said than done.
“Investors drawn by the market presence of the ‘old guard’ VCT managers need to be sure the manager is not simply telling the market what investors want to hear,” he says. “There are very few VCTs that are unaffected by the rule changes.”
Pembroke VCT, which Kin promotes, has been one of the only successful new generalist VCTs in the last 10 years. However, with the rule changes, the playing field has been levelled somewhat, and it is expected that some new players will enter a market which has previously resembled something of a closed shop.
It’s not just about tax relief
Tax relief is not the only draw for VCTs – returns over the last five years have been good. The average VCT investor, assuming they have invested in a portfolio of generalist rather than specialist VCTs, will on average have enjoyed a return of 16% per annum over this period. This includes dividends, but after all costs, and taking into account the initial 30% income tax relief. It compares favourably with a FTSE 100 producing a return of approximately 7% per annum over the same period.
“One of the things investors like about VCTs is they feel more ‘connected’ to the types of companies VCTs back than the rest of their portfolio,” explains Hoskins. “For example, investors in Pembroke VCT can go into Waitrose to buy a Plenish+ smoothie or pop into Five Guys for a burger to judge whether the manager has backed a company that is likely to be successful.”