As Lindsey Rogerson highlighted in Money Marketing recently, a surprising 60 per cent of IFAs are confused by VCTs. This is a worrying statistic considering the increasing role of VCTs as an integral part of investment portfolios and wealth management.Carefully constructed wealth management portfolios contain a diverse mix of assets, including pensions, property, Isas, equity investments, fixed-income instruments and alternative vehicles. The VCT is considered part of the alternative investments sector, alongside enterprise investment schemes and film partnerships. It is surprising that some advisers may have little hesitation in recommending a single-company EIS investment and yet have difficulty in recognising the relative merits of a diversified VCT portfolio. I know which I believe constitutes the greater potential risk – ask yourself the same question. A well balanced portfolio would normally contain up to 10 per cent of total assets in alternative investments. It is our belief that VCTs should be selected for diversification into private equity to enhance the growth and income profile of a wealth management portfolio. Since investors usually have significant exposure to the quoted sector through traditional pensions and equities, it may be appropriate to consider VCTs as a possible alternative to pension additional voluntary contributions. Like pensions, there is 40 per cent income tax relief but unlike pensions, the income is tax free and there is no cumulative limit (so pension caps can be exceeded) and yet if the funds are suddenly needed the investor can gain access to the money. If an individual investor wants to diversify into the unquoted sector, one of the biggest challenges is to access high-quality deal flow. Then there is the need for experience and resources to sort the wheat from the chaff. Unless an investor is seriously wealthy, the level of investment which can be made would normally preclude the ability to negotiate preferential investment terms which capitalise on the upside and yet protect much of the principal. Choosing the right VCT manager is crucial but advisers often seem to overlook the mantra of the true private equity specialists who invest only in businesses and sectors they know well. Thus, it is a mystery that generalists are generically seen as less risky VCTs than specialists. David Morgenthaler of private equity group Morgenthaler Ventures was recently quoted as saying: “The day of the generalist is in decline. The trend has increasingly moved away from the generalist towards specialist.” Specialists have the knowledge and experience to look at each of the investments they are considering not only on its own merits but also as the best of breed. Relationships developed with advisers are the key to success. The advantages of investing in VCTs have been well documented – access to private equity and Aim investments as well as access to fast-growing private companies alongside the tax factors including higher income tax relief (currently 40 per cent) and tax-free dividends and free of CGT while income for pension funds is taxed. The tax breaks should not be listed at the top of the list of advantages although they are useful incentives. VCTs should be viewed as an important medium to longer-term component of a balanced wealth portfolio. We see the cost to the investor as being 1 per share, not the 60p following the tax break and this is how performance needs to be assessed. Clients may think the offer is too good to be true but potential drawbacks need to be addressed. There is confusion as to the benefits and risk profiles of generalists versus Aim versus specialists and charges can be higher than for certain other investments and clearly VCTs must be viewed as a medium to long-term investment, within the alternative investments section of a portfolio. In addition it should be noted some less established VCTs may not meet the minimum subscription level and could be forced to return cheques to investors and although there is no claw back of tax reliefs, VCTs are subject to IHT. How can managers help to educate the market? Traditionally, advisers would turn to VCT guides, first for the adviser to ensure he understands the investment philosophy of the VCT managers and second to educate and inform the client. The majority of guides just give a brief overview but a select few do an excellent job. However, too much emphasis is put on star or numerical ratings. A difference of one point can influence whether a VCT is in the top half or bottom half of the class. Some guides still put a lower risk on Aim VCTs,disregarding the recent run in the public markets while others are more bearish. There is no substitute for face-to-face meetings of VCT managers with advisers. Our experience shows that if advisers understand and then explain all the benefits and risks of a VCT and ensure it is part of a wider wealth management portfolio, clients will have the right expectations and should hopefully be pleased with the longer-term investment returns.