VCTs are in demand – but investors should be cautious this year

Economic gloom has done little to discourage investors from piling into the latest venture capital trust (VCT) offers, with fundraising going strong as the end of the tax year approaches. The amount raised by VCTs this tax year stood at £597mn as of 16 January, only slightly down from the £606mn taken for the equivalent period last year, when the vehicles would go on to raise a record amount.

There’s perhaps good reason for this enduring appeal: frozen tax thresholds leave investors with fewer places to put their cash, and a requirement to hold a VCT for five years to benefit from its generous tax reliefs should instil in buyers the long-term mentality required to look past current challenges. As a reminder, VCT shares come with a 30 per cent upfront income tax relief on the amount you invest, provided you hold them for at least five years. Dividends and capital gains can also be taken tax-free.

When it comes to performance, tougher markets over the past year also allow this year's investors, and VCT managers, to take advantage of lower valuations in some cases. But if VCTs continue to look compelling from a certain perspective, caution should still be a watchword for the time being.

Why? Ben Yearsley, investment director at Shore Financial Planning and a long-time fan of VCTs, describes himself as “circumspect” this time around, for two main reasons.

Firstly, he has grown concerned about the sheer volume of money the industry has raised in recent history. VCTs took on a record £1.13bn in the 2021-22 tax year, and Yearsley worries that with tighter rules putting an emphasis on VCTs backing early-stage growth companies over the past four years, the sheer volume of money chasing deals could prove detrimental to investors.

“If [the sector] keeps raising £1bn each year that’s problematic, as there aren’t that many investment opportunities under the tighter rules,” he says. “Managers either overpay or they go for lower quality.”

His second concern relates to the valuations of the unquoted companies that many VCTs hold, which may face further writedowns. “If you go in, how confident are you about the valuations?” he asks. With that in mind, investors may want to be even more careful than usual, remain aware of the risks that VCTs bring, and remember that risky investments are not the only way to achieve tax-efficiency.

VCT options

VCTs tend to focus on unquoted companies, Aim-traded shares, or a mix of the two, and in Yearsley’s view the Aim-focused vehicles stand out this year, simply because portfolio valuations (and VCT share prices) have corrected significantly over the past year. “That’s where the opportunity is, but the Aim VCTs aren’t raising much money,” he notes. That said, the Hargreave Hale Aim VCT (HHV) had already raised £35mn against a target of £40mn at the time of writing, and as is often the case, such offers can reach capacity quickly. One rival, the Amati Aim VCT (AMAT), has announced no fundraising plans so far.

The Unicorn Aim VCT (UAV) is another option, with a small fundraising effort due to begin in early February. Manager Chris Hutchinson favours businesses where management owns a large stake, partly with the rationale that they should be focused on generating good dividends that they themselves can benefit from. The portfolio contained 85 VCT-qualifying holdings and eight non-qualifying companies at the end of September, with plenty of secular growth stories among the holdings and a bias towards companies in biotechnology and software. The top position at the end of September was in unquoted business Hasgrove, whose subsidiary Interact operates in the software-as-a-service space. But listed positions, such as antibody specialist Abcam (US:ABCM), cell engineering company MaxCyte (MXCT) and video game industry services company Keywords Studios (KWS) also feature prominently.

Wealth Club, an investment service for high-net-worth individuals, notes that while the VCT has no specific dividend target, it does have a history of steady payments, amounting to 35.25p in the past five years, with some 97.2 per cent of the fund's net asset value paid out over a decade. The fund announced its first ever special dividend in November 2021, and the team has said it would consider making other such distributions in the event of future large asset sales. It's worth noting that the VCT's non-qualifying investments are typically in larger, more liquid listed companies. As the fund's latest results put it: "Non-qualifying investments are normally held in the portfolio in lieu of cash, to generate additional dividend income for future distribution to shareholders, while awaiting suitable VCT-qualifying investment opportunities."

Looking beyond those funds primarily focused on Aim-traded shares, VCTs will stand out for different reasons. Jason Hollands, managing director for corporate affairs at Evelyn Partners, favours Pembroke VCT (PEMB) for its targeted approach, specialising in a handful of sectors such as hospitality, fashion and fitness. "What I like about it is that the team focus on a few areas that they know inside out and use a wide network of contacts," he says. Names in the portfolio include Ro&Zo, a women's fashion brand, children's book specialist Annie Mals and London restaurant chain Chucs Bar & Grill.

Wealth Club chief executive Alex Davies, meanwhile, points to a few different flavours of VCT. Perhaps in contrast to the Pembroke approach, a set of VCTs run by Albion Capital provide what the managers describe as an all-weather portfolio, with exposure to a spread of sectors including healthcare, fintech and renewable energy. Each of the six VCTs targets annual dividend payments of 5 per cent via two instalments. Davies also touches on Octopus Titan VCT (OTV2), which backs tech-enabled growth businesses with high potential and has previously held Zoopla (ZPG); and the British Smaller Companies VCTs, which have built "an enviable track record in backing businesses operating within data and analytics, B2B services and new media businesses". Current highlights in the latter portfolios include data analytics platform Matillion and Outpost VFX, a visual effects company that has worked on Lord of the Rings spin-off The Rings of Power.

VCTs are not for everyone

What these options do share in common is a focus on growth companies, and a high level of risk that hopefully leads to a good stream of dividends. However, a potential slowdown in asset sales in the current climate could mean that such dividends, which tend to form the main part of a VCT's returns, become more lumpy for the few funds that are relatively new. "More mature VCTs still do have some legacy investments they can exit, and others can use cash reserves to sustain a dividend," Hollands notes. "If a VCT has only launched in the past couple of years it may take a while."

Finally, it's worth remembering that VCTs are not for everyone. They are best suited to sophisticated, risk-on investors who already have a diversified portfolio and have made use of their tax wrappers. Some other methods, such as transferring assets to a spouse, can be another way of maximising tax-efficiency without turning to such risky investments.