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Are VCTs set to benefit from the UK recovery?

A slew of recent data suggests that the UK economy is on the mend with manufacturing order books back to pre-financial crisis levels, improving sentiment and the Bank of England Monetary Policy Committee upgrading its growth forecasts. Of course the news isn’t all positive, with a fall in retail sales in August one surprise spanner in the works.

For investors wanting to access the UK domestic recovery as an investment theme, it isn’t as simple as buying UK equities. That’s because around two-thirds of earnings of the FTSE 100 Index, which includes many large international corporations, are derived overseas. Mid-sized UK shares have a greater bias to the domestic economy, though these shares have already reached quite high valuations as optimism has spread.

One niche area that could be of interest for investors who are comfortable with higher risk investments, is Venture Capital Trusts (VCTs). These are specialist investment funds which list on the London Stock Exchange and are designed to facilitate investment into small, unquoted enterprises that must carry out their trade wholly or mainly in the UK. That means small businesses that are invariably nearer the coal face of the UK domestic economy than many much larger listed companies. Companies that have previously received or currently have VCT backing include the likes of retailers Bench, Fat Face and Crew Clothing; property website Zoopla and travel firm Iglu.

As higher risk investments, the Government provides a range of tax incentives for investing in VCTs. These include a 30% income tax relief for investing in a VCT new shares issue (which must be repaid if the shares are sold within five years), tax free dividends and capital gains. Although VCTs invest in small growth companies, returns from VCTs are often channelled back to shareholder through tax-free dividends, so VCTs can be suitable for income investors.

In our view, VCTs should only be considered by long-term investors who are subject to the higher rates of tax and for whom VCT investments will only constitute a modest part of their overall portfolio.

We expect a number of VCTs to seek to raise new funds over the coming months as managers have indicated to us that they believe there are increased opportunities to find attractive deals in the current economic environment. For more information on VCTs, including their risks, download our free Venture Capital Trusts Guide.  For details of VCTs currently open for investment including our research notes, discounts, application forms and ratings click here.

VCTs should be regarded as higher risk investments. They are only suitable for UK resident taxpayers who can tolerate higher risk and have a time horizon of greater than five years. Past performance is not an indication of future performance. Share values and income from them may go down as well as up and you may not get back the amount originally invested. Owing to the nature of their underlying assets, VCT's are highly illiquid. Investors should be aware that they may have difficulty, or be unable to realise their shares at levels close to that that reflect the value of the underlying assets. Tax levels and reliefs may change and the availability of tax reliefs will depend on individual circumstances. You should only subscribe for new VCT shares on the basis of the relevant prospectus and must carefully consider the risk warnings contained in that prospectus.