Some months ago we predicted that 2013/14 could see a “sweet spot” for Venture Capital Trusts (VCTs) and today (20 January 2014) the Association of Investment Companies, which represents a large number of VCTs, has confirmed that VCT fund raising is indeed 69% up so far this tax year compared to last year.
With over £600 million of capacity this year and a large number of offers open, investors are spoilt for choice. However, it is vital to be selective when investing in such specialist vehicles.
What is driving supply and demand?
Supply: the UK is recovering but corporate bank lending is weak
VCT managers are seeking funds in their droves, and the consistent message is that the UK domestic recovery is creating strong pipelines of new investment opportunities as appetite for expansion and MBOs creates demand for financing.
As a scheme which is focused on small trading businesses that must operate wholly or largely in the UK, VCTs are investing at the coal face of the domestic recovery, unlike funds investing in listed UK equity markets where companies are more international in nature.
Yet an unusual feature of this abnormal recovery is that that corporate lending by banks remains very weak, prompting the British Chambers of Commerce to warn earlier this month that constrained bank lending could derail the recovery. That is helping fuel demand for VCT financing, much of which is provided via loan notes rather than equity stakes.
Demand: taxes remain high, pension allowances reduced and income is scarce
VCTs are not for everyone as they are specialist investments and you need to understand their quirks and risks, as well as the tax benefits. In our view the target market is very much higher earners who already have portfolios of mainstream investments and can add a small weighting to VCTs.
The upper rates of personal tax remain high in the UK – with little prospect of a cut with a General Election looming – and there have been significant reductions in both the annual and lifetime pension allowances recently. Contributing to a pension has traditionally been a popular way for higher earners to mitigate punitive levels of taxation.
More affluent investors are therefore looking to VCTs as an add-on alongside ISAs and pensions, in the knowledge that these schemes enjoy statutory backing. Investors are rightfully wary of more dubious forms of aggressive tax planning (loopholes), which the Revenue is cracking down on. In contrast VCTs are helping deliver Government policy objectives of supporting small enterprises.
Another factor creating demand is that the majority of schemes raising assets are mature VCTs, not new schemes. Mature VCTs are generating very attractive tax-free yields at a time when income remains in scarce supply for some other asset classes. If the recovery can be sustained, we think this also raises the potential for mature VCTs to accelerate exits from existing holdings, which would support future special dividend payments.
Find out more about VCTs, including their risks by downloading our free guide