Pensions put VCTs in spotlight

Steve Marshall, Sales and Marketing Director

Last week’s budget announcement of a further cut in the tax free pension lifetime allowance to £1 million has once again raised the profile of VCTs as tax-efficient home for capital and attractive source of tax-free income.

VCTs have really found their place in the minds of investors, whether for tax or income planning. Although they are higher-risk investments and clearly not right for everyone, VCTs can be highly suitable as part of a broad investment portfolio for investors who can comfortably invest for the minimum five year holding period to retain the tax breaks.

Remarkably VCTs have now been around for 20 years, and perhaps their defining feature is the ability to combine a raft of tax benefits with access to good quality smaller companies that most investors couldn’t access elsewhere.

The 30% income tax rebate, tax-free dividends and CGT exemption are a significant incentive for investors who are attracted by the chance to back smaller and privately owned businesses. The well managed VCTs have proven their ability to deliver attractive regular income, which investors increasingly see as supplementary to their taxable pension income after recent cuts to both the lifetime pension savings limit and annual contribution ceiling. And with tax mitigation very much in the spotlight recently, it’s worth reminding ourselves that VCTs were created by the government specifically to promote investment in the smaller company sector that is so crucial to the UK’s economic prosperity.

Generalist VCTs in particular have a proven record or consistent investor returns. The well managed trusts each invest in a diverse portfolio of typically 30 to 40 private companies, often later-stage businesses with proven business models and revenue streams, and are able to structure those investments with a medium to long-term horizon, so that each company pays an income to the VCT and maximises the chance of significant returns at exit.

Unlike limited-life VCTs these evergreen funds do not have to invest to a fixed timeframe, and investors are increasingly using the dividend streams from established generalist funds as part of a longer term income strategy.

Perhaps the key factor for most investors we speak to is the quality of the manager, as the ability to find and make the right investment, and then manage those assets through to profitable exit, is pivotal.

The asset selection process for private companies is intensive and hands-on, and couldn’t be more different to that of a typical equity income fund manager scanning the quoted markets. A good VCT manager has a large and highly qualified team, steeped in what makes smaller businesses succeed and with experience of helping them do it. Successful VCT fund management means looking at hundreds of business plans each year, visiting their offices, factories and workshops, and picking those run by entrepreneurial teams with a clear vision for growing that business.

And as VCTs are at the higher risk end of the investment spectrum, investors need to see that the VCT manager has the expertise to effectively manage the risks – the established managers have shown an undoubted ability to do that, from the initial selection process, through sourcing a diverse range of assets across a number of sectors, to working closely with the company to optimise its performance.

So good VCT management doesn’t stop at the point of investment, it’s about providing more than just finance – the key to leveraging both the VCT manager’s experience and the strengths of each investee business, is in active and supportive portfolio management. The successful managers place huge emphasis on providing strategic advice for as long as they are invested, usually taking a seat on the board – that is where the combined expertise and market knowledge can significantly increase a company’s value and achieve profitable exits for shareholders.