Top VCT tips for early investors

Over a number of years the VCT investment season has gradually started earlier and, this year, most of the VCT offers expected are already raising money from investors. However, some of the most popular generalist VCTs - the Northern and Baronsmead 1 to 4 funds - say they are not raising money in the 2014-s15 tax year, meaning there is less choice for investors.

Earlier this month Northern confirmed that they would not be raising money this year. The Northern VCTs raised £50m in 2013 and NVM Private Equity had already told Investors Chronicle last November that they have enough cash so would not be rushing to do another big raising.

Read the interview with Northern Private Equity's chairman

Michael Probin is an investor relations director at ISIS Equity Partners, which manages the Baronsmead VCTs. He says: "One of the reasons why we are not doing a large raising is because we had a series of very profitable realisations and have paid significant dividends to shareholders. We do not need to raise money for investment purposes."

These developments put investors in something of a quandary.

One the one hand, if you think you are going to invest in VCTs then you may need to do it early, especially if there is a specific fund you want as offers may sell out. Some VCTs also do early bird special offers when they launch a raising so you can save on the charges.

VCT early bird offers

Source: Clubfinance

On the other hand, if your income is not predictable and you do not know your tax position then you need to wait till the end of the tax year to clarify this. Many higher-earning investors only tend to focus on tax issues in the run-up to the end of the year when they have a clear idea of their overall potential tax liability and also, for city workers in particular, once bonuses have been paid.

A handful more offers are due. Baronsmead VCT 5 (BAV) will do a small top-up offer in January 2015 of around £4m: it is keeping it small because it does not want the expense of producing a prospectus or risk performance drag because it is holding cash.Downing ONE VCT (DDV1), which holds a mixture of unquoted companies and Alternative Investment Market (Aim) shares, is expected to come to market in December seeking £10m. Plus, the Albion VCTs have launched a £25.5m top up fundraising, but have the capacity to increase this to £36m should there be demand and investment opportunities into which to deploy the cash.

Open VCT offers

Source: Tax Efficient Review and Clubfinance

*These dates are intended as a guide and should be checked with the fund provider.

Top VCT picks

GENERALIST VCTS

Generalist VCTs mainly invest in unquoted companies and tend to allocate across a variety of sectors. There is a good choice of generalist VCTs to choose from despite the Northern and Baronsmead 1-4 funds not coming to market.

Tilney Bestinvest rates British Smaller Companies VCT (BSV) and British Smaller Companies VCT2 (BSC) 5 star - its highest rating.

The British Smaller Companies VCTs invest across a broad range of sectors with a good spread of companies in: manufacturing; retail & brands; business services, software/IT/telecommunications and healthcare. Examples of their investments include outdoor clothing & equipment retailer GO Outdoors, British Smaller Companies VCT's largest holding. The company's turnover has increased from £2m to over £200m, and YFM Equity Partners, which manages the British Smaller Companies VCTs, sold a minority stake in this company to 3i (III) in 2011 realising £6.5m in cash. YFM says it has achieved a total return representing 30x cash invested.

"These are established and mature portfolios, investing predominantly in unquoted growing companies, funding management buy-outs and growth capital opportunities," comments Bestinvest. "A key differentiator of the British Smaller Companies VCTs is their focus on opportunities in the UK regions, made possible by their regional footprint, rather than concentrating all of their time and efforts in London and the South East, where competition is typically much higher. The majority of the VCTs' investments are in management buy-out (MBO) and management buy-in (MBI) opportunities with a much smaller proportion in development capital deals, funding a number of expansionary strategies including exploiting proprietary technologies, developing brands and international expansion."

Martin Churchill, editor of research site the Tax Efficient Review, rates the four Mobeus VCTs as his top scoring Generalist VCT offering based on their track record to date and successful exits in the last year. These are doing a collective raising of £39m.

Mobeus Income & Growth VCT (MIX), Mobeus Income & Growth VCT 2 (MIG), Mobeus Income & Growth VCT 4 (MIG4) and The Income & Growth VCT (IGV), invest in a blend of equity and loan stock which provides some downside protection. Their portfolio management team is well resourced and they have had profitable exits from deals in the last two years. The funds mainly focus on investing in the management buyouts of established profitable businesses with the aim of generating attractive dividends.

Examples of portfolio holdings include ATG Media, the largest holding in Mobeus Income & Growth VCT's portfolio. The company does webcast and timed online auction platforms, and in the last year, its sites, including leading art and antiques portal, the-saleroom.com, sold over £260m of product online.

Ben Yearsley, head of investment research at Charles Stanley Direct, recommends the Maven VCT 1-5 VCTs. "This is a good quality house which pays consistent dividends," he says.

These focus on established, cash-generative companies on sensible earnings multiples. These invest across various sectors with a particular specialism in oil and gas service companies.

Since March 2012, the Maven VCTs have made ten realisations, examples including Nessco Group, which provides telecommunication services to the energy and industrial sectors. During the Maven funds' period of investment Nessco's earnings grew over 200 per cent.

Aim VCTS

There are other types of VCT offers available, for example Alternative Investment Market (Aim) VCTs. However, these have quite different characteristics to generalists as they largely invest in Aim shares rather than unquoted companies, and typically have a lower level of yield. Generalists will also hold loan notes rather than shares in some of their companies, which are higher up the repayment structure in the event of default. And because generalists largely invest in unquoted companies they provide more diversification for investors whose investments are focused on listed equities.

Of the four Aim VCT offers open at the moment, Bestinvest gives its highest five-star rating to Unicorn AIM VCT (UAV), which is seeking £15m. This is the largest Aim VCT with assets of around £95m. "This is a diverse and mature portfolio containing 47 VCT qualifying holdings, and a number of individual non-qualifying holdings, and will also give investors some exposure to three of Unicorn's open-ended funds," comments Bestinvest. "The VCT is managed by Chris Hutchinson, who has a strong track record."

Unicorn Aim VCT's largest holdings include Abcam (ABC), a global supplier of protein research tools; Tracsis (TRCS), a provider of resource optimisation software for the transport industry and Anpario (ANP), a manufacturer of natural food additives for the pig and poultry industries.

Mr Hutchinson aims to identify companies with well-established business models which are cash generative and have the ability to grow their existing dividends. These companies must be profitable prior to initial investment.

PLANNED EXIT VCTS

Planned exit VCTs are not necessarily a substitute for generalists: these aim to wind up as soon as possible after five years and protect rather than grow capital, although there is no guarantee as to how soon these will wind up, and it is unlikely to be the moment they hit their five-year anniversary. These are better for tax planning over a shorter period.

Of the planned exit VCTs in the market this year, Tilney Bestinvest gives a five-star rating to Puma 11 VCT. Puma has a good track record with its previous VCTs, and a strong focus on capital preservation and downside protection. It will invest in unquoted, established, cash-generative companies run by experienced management teams.

Tips for researching VCTs

When choosing a VCT, look at its dividend policy and to what extent it hits its targets, as consistency is important. Dividends are an important part of the return from generalist VCTs, and an added attraction is that they are tax free. But the VCT should also not be losing capital.

You should also think about how the managers will get out of the investments and understand what you are investing in, and the strategy and the stage of development of the companies. Generalist VCTs in particular have many different strategies.

"Also assess where a VCT's performance record has come from: is it just off the back of one or two successful deals?" adds Matthew Woodbridge, vice president, wealth and investment management, at Barclays. "And consider how future returns will be generated."

You can find useful research on VCTs at the www.taxefficientreview.com website, including a valuation service, although this is not free. VCTs' offer documents and annual reports should contain a good deal of information and you can check performance data on websites such as www.bestinvest.co.uk, which also rates VCTs.

www.theaic.co.uk has extensive data on VCTs including performance and fees.

You can find lists of open offers on websites such as www.taxefficientreview.com and www.clubfinance.co.uk.

A downside to VCTs is their relatively high fees with ongoing charges typically well above 2 per cent, and in some cases over 4 per cent. A reason for this is because 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. Many VCTs have a performance fee, as is common among private equity and hedge funds.

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. VCTs are relatively small funds so these costs are also being spread across a small asset base, though Mr Yearsley argues that a number of these funds have grown in size over the years so could reduce their fees.

PERFORMANCE OF VCTS

Taking the top 20 performing VCTs over the last 10 years, with 3.5 per cent taken off the return to represent expenses, 12 of these beat the FTSE All-Share, and 17 beat the FTSE Small Cap Index, according to figures from the Association of Investment Companies (AIC). This is before the effects of the 30 per cent tax break VCT investors get if they buy shares at issue and hold them for five years.

Most of these top performing VCTs are from the generalist sector, and have also paid out a good level of dividends since launch, an average of 79.37p a share according to the AIC. The AIC adds that as the sector has matured dividends have also become more consistent - including in difficult periods such as 2009.

The VCT which has paid out the most in dividends per share since 1999 is ProVen Growth & Income (PGOO) (158.9p) followed by Baronsmead VCT (BDV) (133.41p) and Northern Venture Trust (NVT) (121.10p), which is also the third top performing VCT over the last 10 years, up 220 per cent. Close behind in dividend payments is ProVen VCT (PVN) (120.2p).

Read more on assessing VCT performance

Return on £100 lump sum of top performing VCTs with 3.5% expenses taken into account

Source: AIC using Morningstar as at 30 September 2014

Regular reporting

A change affecting a number of VCTs and other listed companies is the removal of the requirement to publish interim management statements. This means VCTs listed on the main market will only have to publish annual and half-yearly reports, rather reporting four times a year.

"I am against this because having a VCT's net asset value (NAV) reported only every six months is not enough," says Mr Churchill. "We are always against restricting information particularly in the VCT arena where investors are not regularly deciding to hold or sell their investment, and where the shares are not covered by much research."

One of the reasons given in the FCA consultation document is that publishing interim management statements is a burden on small companies. "This makes no sense for VCTs as the marginal cost of a Regulatory News Service (RNS) announcement is virtually nothing and the manager prepares monthly reports on investments in any case," says Mr Churchill.

Mr Woodbridge agrees. "Having a quarterly update is very useful so you can know what is happening with your fund," he says. "This level of transparency is an advantage VCTs have over Enterprise Investment Schemes (EIS). A VCT may have been holding a company for several years so it is useful to see if you are getting positive value."

This is a particularly relevant issue for funds which invest in unlisted investments such as property or unquoted companies. With listed funds such as investment trusts which invest in equities, it is easier to work out the NAV as the underlying holdings have a share price which is publicly available. Data companies such as Morningstar can publish a daily NAV, either getting the information from the investment trust or London Stock Exchange.

Aim VCTs, meanwhile, typically publish their NAV once a week.

But unlisted investments such as property or unquoted companies have to be valued so getting their NAV relies on them providing a valuation. Removing the obligation to do interim management statements might mean VCT investors only get NAV updates twice rather than four times a year.

However, even though VCTs had to publish an interim management statement this did not necessarily include a NAV calculation, and they are unaudited, points out Mr Yearsley.

Philip Rhoden, director at discount broker ClubFinance, says: "VCTs will still be required to disclose price-sensitive information as soon as possible. NAVs can be disclosed via the RNS on a voluntary basis - even before the rule change, you can see examples of VCTs publishing an RNS to report their NAV on a monthly or more frequent basis. The practical impact for many investors may be small remembering that VCTs are longer-term investments, with a five-year minimum holding period for new shares to retain their upfront income tax relief."

We spoke to five of the main generalist VCTs, and four of these - Albion, Northern, Baronsmead, and Mobeus - said they will continue to do quarterly statements and these will include a NAV valuation.

Maven meanwhile is recommending to the boards of its VCTs to continue to issuing interim statements, and while it has not been decided exactly what they will include, at a minimum they will publish the NAV.

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