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Avoiding landmines: tips to consider when choosing a VCT

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With less than a month to go until the end of the tax year, this is probably the last chance for another year for your clients to select a venture capital trust.

There is a vast array of VCT options available so what should advisers look for and what does the sector offer to best meet specific client needs?

VCTs fall in to four main categories for investors: Generalist, Planned Exit, AIM, and Specialist. Each category has its particular characteristics, determined by the nature of the underlying investments the VCT manager makes.

Generalist VCTs invest into the equity of qualifying companies, which maximises the upside potential but the exit from each investment is determined by another party buying that equity – hopefully at a higher price than what the manager paid for it originally.

Planned Exit VCTs on the other hand typically make investments in the form of secured loans to qualifying companies. This limits the upside, but means that the manager has more control over the timing of exits from the fund’s investments, and hence has more ability to achieve cash distributions to investors on time. Often this suits investors choosing a VCT to access the tax relief rather than positively to select venture capital as a sector in which to invest. Advisers should be looking to match the VCT to the client’s objectives of risk versus reward.

Against a backdrop of an improving economy and a resurgent market, AIM VCTs seem to becoming more popular again. These VCTs can only invest in new AIM shares and short-term income is not always guaranteed.

Specialist VCTs are focussed on investing into particular sectors e.g. films or renewables. This may help or hinder deal flow. It may also mean that, when the Government changes the rules as it did for solar VCTs  two years ago, they come under pressure to invest too much too quickly.

But having considered your clients’ risk profile, once you have decided on the types of VCT, the question is how to select the most suitable from the group available. There are a number of points which advisers may find useful when assessing the plums from the lemons of the VCT market. 

  • Track record – has the VCT manager displayed consistent returns against their peer group? In particular, what has the dividend stream been over recent years? The ability to pay out tax-free dividends is one of the most effective ways for VCT managers to return capital to shareholders.
  • Size – small VCTs can have a high level of fixed costs, which will impact on the overall performance of the fund.
  • Experience – how long has the manager been investing into smaller companies? Did the manager invest in private equity before they became a VCT manager? Is their due diligence process robust?
  • Exit – how is the shareholder going to be able to realise their investment in the VCT? Does the VCT manager employ an exit mechanism, and if not, do they buy-back shares to minimise the discount to the NAV? It does not impress shareholders to see a high NAV and the shares trading at a large discount to it. Planned Exit VCTs can return capital to shareholders, avoiding the need to sell shares at a discount in the secondary market.
  • Investment plans – if the manager plans to invest much of the money very quickly, for example because a relief is changing, be suspicious.
  • Group size – does the VCT manager just run VCTs, or are they part of a larger group, whose resources and expertise they can draw upon. If VCTs are all they do, are they incentivised to maximise dividends to shareholders if this reduces their assets under management? 

Eliot Kaye is investment director at Puma Investments

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