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The truth about VCT performance

Assessing a VCT's performance is much more complicated than with a conventional equity fund
March 19, 2014

Much is made of the generous tax breaks on venture capital trusts (VCTs) but you should not forget about performance. As with any fund sector, there are VCTs which have performed well and ones which haven't.

Assessing a VCT is not as simple as choosing a unit trust or open-ended investment company (Oeic) - there are many things to consider including past performance. While not a definitive guide to which VCTs have done well, the ones raising funds this year and in recent years have generally been successful.

"Many poorly performing VCTs are no longer raising funds because they can no longer attract new investors or have been merged into other VCTs," says Matthew Woodbridge, vice president, Barclays Wealth and Investment Management. "Conversely, several of the established generalist VCTs which are currently raising money have performed well relative to their peer group over the long term."

A problem with assessing past VCT performance arises when a fund has been taken over by a new manager. There have been a number of VCT manager changes and mergers so the past performance is not necessarily indicative of what might happen going forward. Mr Woodbridge says this can be a particular problem with linked offers: even if a VCT has a new and better manager it takes time with unlisted investments to overhaul the portfolio, and a recently acquired VCT might have different investments to the others in its family.

"Bad VCTs tend to disappear - some have literally gone bust while others have been taken over by other VCTs," adds Ian Lowes, managing director of Lowes Financial Management. "This can mean that you do not get a proper picture of the sector by looking at performance tables because certain ones have disappeared. That said, what is left is generally much better."

VCTs are listed like investment trusts so you have both share price and net asset value (NAV) performance to consider. Martin Churchill, editor of the Tax Efficient Review, argues that NAV is a better measure because it shows what VCTs' investments have actually done. Share prices can be moved by a number of things other than how well a fund or company is doing, such as a share buyback policy rather than the investments' performance.

"The investor gets the share price back rather than NAV, but generalist VCTs are for holding for the long-term - they are not trading instruments," he says.

You have to hold a VCT for a minimum of five years to obtain 30 per cent income tax relief, and in the case of generalist VCTs there is an argument for holding them longer because they make their profit from small unquoted companies which can take many years to grow to maturity and sell.

"The share price can be meaningless because, for example, a manager can let it slide and improve it with share buybacks over a year and make it look fantastic again, with the discount to NAV tightening," adds Mr Churchill.

However, Mr Woodbridge says the discount to NAV is an issue when you want to get out. "With generalist VCTs in particular, how the share price is managed relative to the current NAV and the manager's relationship with market makers is important, because it can have a big impact on what you receive upon exit."

Dividends

Dividends are a key way investors get their return from VCTs, and some investors buy and hold VCTs to receive an income stream from the tax-free dividends. "One of the main concerns for generalist VCT investors, especially over the shorter term, is the dividends so this is a key thing to look at when considering performance," says Richard Troue, head of VCT research at Hargreaves Lansdown. "Shorter-term fluctuations in NAV or price shouldn't be too much of a concern to long-term investors, though of course any extreme movements or anything which appear out of the ordinary will warrant investigation.

"Over the long term dividends will be equally important. I look for VCT managers with a good track record of paying consistent, steady dividends - managers such as Baronsmead, Maven, YFM and Mobeus are building good track records in this respect.

"Ultimately the total return an investor receives will be comprised of dividends plus NAV growth. Tax-free dividends are the primary source of returns from VCTs, but it's also good to see them growing the NAV over time as well."

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However, Mr Churchill points out that VCTs can currently pay dividends out of capital which isn't an indication of the good health of a VCT. "You need good capital growth and a good distribution," he says.

And unlike unit trusts and Oeics that just distribute income a VCT can distribute realised ‎gains and so if they do, they are distributing assets so the NAV will be less post distribution. "You need to look at the total return (because of the dividend) but it is often hard to follow," says Mr Lowes.

But Mr Churchill says that total return does not take into consideration the time value of money: 100 per cent over one year can be a very different figure to 100 per cent over five years. Rather he favours assessing a VCT by its internal rate of return (IRR) which brings a number of things into the calculation.

This is calculated by subtracting 30p (the income tax break) from 100p (the price you pay for a new issue) and adding the dividends and NAV to this.

"IRR which is the annualised effective compounded return rate or rate of return that makes the net present value of all cash flows (both positive and negative) equal to zero," he says. "I calculate it on a daily basis using the net of income tax relief original cost (a negative cash flow), the flow of dividends on the date they were paid and the NAV published in the latest quarterly report from the VCT (both positive cash flows).

"I favour the IRR over measures such as total return as it factors in the time value of money and rewards early distributions of cash. Its benefits include that it produces a single number to compare between VCTs and recognises early payments are good. However, it assumes interim cash flows are reinvested at the IRR rate which is not true. But overall benefits outweigh the drawbacks."

Generalist VCTs have produced average IRRs between 3 and 16 per cent. There is tremendous variance between the best and worst funds, however, so picking the right fund is important (see table).

Generalist VCT IRRs from launch to last quarterly disclosed net asset value

Tax year launchedNUMBER OF FUNDSBEST IRRWORST IRRAVERAGE IRR
1995/9679%-2%5%
1996/9769%-1%5%
1997/9879%0%6%
1998/9959%-2%4%
1999/0069%-1%5%
2000/011510%-7%3%
2001/02714%-8%3%
2002/03611%-6%4%
2003/042516%-7%3%
2004/052322%-4%10%
2005/062117%-15%8%
2006/07815%-7%5%
2007/082416%-7%8%
2008/092231%0%16%

Source: Martin Churchill Tax Efficient Review

Internal Rate of Return calculated after initial tax relief and using last quarterly announced Net Asset Value. Returns are not grossed up to reflect that they are tax free.

AIM VCT IRRs from launch and to last quarterly disclosed net asset value

Tax year launchedNUMBER OF FUNDSBEST IRRWORST IRRAVERAGE IRR
1995/9615%0%5%
1996/9714%0%4%
1997/9847%-1%2%
1998/9922%-2%0%
1999/0032%-4%-1%
2000/01911%-4%0%
2001/0256%-3%1%
2002/0345%-2%2%
2003/0448%-3%3%
2004/051611%-1%5%
2005/061811%-3%4%
2006/07512%0%7%
2007/08214%0%13%

Source: Martin Churchill Tax Efficient Review

Internal Rate of Return calculated after initial tax relief and using last quarterly announced Net Asset Value. Returns are not grossed up to reflect that they are tax free.

 

Meanwhile Simon Blowey, divisional director - financial planning at Brewin Dolphin, looks at a number of factors when assessing a VCT for clients, as follows.

■ Liquidity (how easy it is to buy and sell);

■ reduction in yield (all charges, implicit and explicit, not including adviser fees);

■ diversification;

■ performance and size of funds under management of specific fund; and

■ profitability of the manager and total funds under management.

 

Limited life VCTs

Limited life or planned exit VCTs aim to wind up and return capital to investors as soon as possible after five years. Because these funds do not remain open and you buy into a new fund, you can't look at their past performance.

The risk with limited life VCTs is that you cannot get out within a reasonable amount of time after five years. So when choosing one, things to assess include the manager's ability to wind up the VCT within a reasonable amount of time after five years, and without losing investors' money. One indication is how successful they have been with their past funds.

Mr Churchill says investors should also consider in what area the limited life VCT plans to invest its money, what is the potential upside of this area, what are the risks, how easy is it to buy and sell assets in this area, and how likely it is you can get out of them after five years.

He says that managers such as Puma and Ingenious have successfully got investors out, whereas Triple Point has lost money when getting people out.

Downing 6, 7, 8 and 9 VCTs, and Edge VCT share classes C, D, E and F are having difficulty in getting investors out of those funds because of the illiquidity of some of their holdings.

Mr Churchill adds that limited life managers who are only preserving NAV at around 100p "aren't shooting the lights out," even though the investor sees some uplift as they went in at 70p after the income tax break.

 

High fees

A downside and detractor to VCT performance is the relatively high fees, with ongoing charges typically well above 2 per cent, and in some cases over 4 per cent.

A concern with high fees is that they take away some or all of the benefit of the 30 per cent income tax break, especially if you are a long-term holder as over time the costs stack up.

However, investing in unquoted companies is more labour intensive and expensive than buying shares. It involves more research and a lot of due diligence, plus the VCT managers may sit on the boards of the companies they invest in. Having the right expertise is important as private equity funds are complex to run.

Read more on VCT charges

VCTs are relatively small funds so these costs are also being spread across a small asset base.

Mr Lowes says that you can expect to pay more for a VCT than a conventional equity investing unit trust or Oeic, but you should still watch the fees. "Where you are only getting a 40 to 50 per cent gain after five years including tax relief there are arguably better ways to do that and with less risk," he says. "Just getting your tax relief back is not attractive for a high-risk investment - this is the sweetener for taking the extra risk."

Looking at five year VCT returns on a £100 with 3.5 per cent taken off the return to represent charges, stamp duty and market spread, 13 funds beat the FTSE All Share Index and two beat the FTSE Small Cap Index. This data is before the effects of your 30 per cent income tax.

Over ten years, nine VCTs beat the FTSE All Share and fifteen beat the FTSE Small Cap Index.

30 best performing VCTs over five years

Venture Capital TrustShare price total return on £100 (£)
Oxford Technology VCT819.33
Maven Income and Growth VCT 2356.01
Rensburg AIM VCT343.68
Hygea VCT333.08
Amati VCT 2292.65
Maven Income and Growth VCT289.12
Octopus AIM VCT275.12
Maven Income and Growth VCT 6273.27
Maven Income and Growth VCT 3266.3
Northern Venture Trust253.68
Unicorn AIM VCT248.29
Northern 2 VCT245.76
Hargreave Hale AIM VCT 1239.46
Northern 3 VCT219.33
Downing ONE VCT211.35
Maven Income and Growth VCT 4209.08
Crown Place VCT207.42
Kings Arms Yard VCT197.13
Artemis VCT196.01
Octopus AIM VCT 2192.41
Baronsmead VCT 2186.43
Hargreave Hale AIM VCT 2186.29
Baronsmead VCT185.49
British Smaller Companies VCT181.32
Amati VCT180.15
Baronsmead VCT 3179.07
British Smaller Companies VCT 2177.84
Foresight VCT176.08
Maven Income and Growth VCT 5172.42
Mobeus Income & Growth VCT167.88
FTSE All Share Ex Investment Trust TR GBP

226

FTSE Small Cap Ex Investment Trust TR GBP

349

Source: AIC using Morningstar as at 28/02/2014

Includes £100 Lump sum. 3.5% expenses taken into account for VCTs

30 best performing VCTs over 10-years

Venture Capital TrustShare price total return on £100 (£)
British Smaller Companies VCT431.09
Northern Venture Trust378.61
ProVen Growth and Income VCT362.76
ProVen VCT334.71
Income & Growth VCT301.79
Maven Income and Growth VCT286.27
Oxford Technology VCT272.94
British Smaller Companies VCT 2239.52
Baronsmead VCT 3236.98
Baronsmead VCT 2230.52
Albion Technology & General VCT230.21
Baronsmead VCT228.55
Northern 2 VCT215.89
Baronsmead VCT 4211.76
Albion Development VCT208.97
Elderstreet VCT207.24
Maven Income and Growth VCT 3199.58
Maven Income and Growth VCT 2191.89
Crown Place VCT182.11
Rensburg AIM VCT180.71
Northern 3 VCT179.06
Foresight VCT150.83
Mobeus Income & Growth 4 VCT147.24
Hygea VCT134.02
Chrysalis VCT129.53
Albion VCT129.27
Kings Arms Yard VCT115.57
Foresight 3 VCT106.6
Oxford Technology 3 VCT102.64
Foresight 4 VCT95.7

FTSE All Share Ex Investment Trust TR GBP

231

FTSE Small Cap Ex Investment Trust TR GBP

208

Source: AIC using Morningstar as at 28 February 2014

Includes £100 Lump sum. 3.5% expenses taken into account for VCTs