Due diligence around VCTs does not need to be more difficult than a more general fund but advisers must really focus on the client’s risk level
As with any other investment ‘research is everything’ when it comes to picking VCTs and deciding on client suitability, say industry experts.
Like other investment propositions, VCT managers produce plenty of information packs to help support advisers in making the right choice for their clients but plenty of IFAs still seem wary about dipping a toe into the alternative investment world. But they have to remember that picking a VCT is no more difficult than picking a more standard fund.
Tony Catt, Compliance Officer at TC Compliance Services, says ‘research is everything’.
‘Most VCTs can produce some lovely, glossy documents so there’s plenty of information about the fund and the investee companies within that; that’s useful background information,’ he says.
Catt says advisers may use Growthinvest, a platform that provides access to tax efficient investments, to compare.
‘Once you’ve done that research, and then the suitability, you can probably cut and paste some of the documents,’ he says.
He adds that advisers probably do not need to do anymore ‘as they’ll have their investment template and these funds are just another within a portfolio’.
Annabel Brodie-Smith, Communications Director at the Association of Investment Companies (AIC), says the AIC website has a wealth of ‘statistical data on VCTs’.
Of course, VCTs are by their nature higher risk because investing in smaller start-up businesses is inherently risky. This means they will be suitable for a smaller demographic of clients, however, this doesn’t mean the suitability report has to be any different from the standard suitability checks that IFAs are used to.
‘The burden is gaining the knowledge to advise and recommend, but once you have that, it’s just like any other fund,’ says Catt.
He says when he was an adviser, VCTs would have only been suitable for one or two clients. Even if the VCT is suitable for a client, this doesn’t mean they will have the confidence to agree to the recommendation.
‘I did all the research [on VCTs for the clients], I did a 30-page report, I knew all about them by the time I was telling the client, but it was the confidence of the client thinking [whether] they should take the step and if they need to take this step with this risk,’ he says. Catt says advisers should be asking: ‘does the client need to take that extra level of risk?’
‘Tax efficiency is one thing but the risk level [is another]. The Financial Conduct Authority (FCA) doesn’t want a granny to use it as an ISA and the whole thing might go down as the risk hasn’t been explained,’ he says.
Instead, the VCT should be part of a portfolio so that ‘froth at the top is the bit of excitement’ and the client should invest in ‘lots of other things before looking at the VCT’.
‘The VCT is the sporting element of the portfolio to add a bit of zing and bit more return,’ says Catt.
For advisers who are not confident about recommended tax-advantaged investments, the level of due diligence may not seem cost effective.
Catt says the advisers coming back to do increased due diligence will ‘take longer to do the research, so they’ll wonder if it’s cost effective’ to advise on alternative investments.
He describes third-party research house as ‘invaluable’ but says the reputation of the firm is key.
John Glencross, Chief Executive of Calculus Capital, says that researching the research houses is also important as ‘some are reputable’ and one adviser will think one is legitimate and another will think it is terrible.
‘By and large they have different ways of expressing themselves but it’s probably okay if you go to one of the well-known firms and use their research intelligently,’ says Glencross.
The suitability, or not, of VCTs has not escaped the scrutiny of the regulator, with the FCA undertaking a thematic review into overall IFA due diligence.
Glencross, says the FCA was concerned about whether IFAs had done a ‘proper investigation’ of investment product recommendations.
‘That probably meant that, given that most IFAs cover a wide range of products, that they had access to third-party research and that it’s appropriate in terms of quantum within an overall portfolio,’ he says.
Glencross says those are ‘sensible things for an IFA to do anyway’ that means an IFA has fulfilled their requirements as far as the FCA is concerned. Although he adds that this may not be enough for professional indemnity insurance providers who ‘seem to be behind the curve in understanding the industry’ meaning advisers may find it hard to get the relevant insurance when advising on alternative investments.
Catt says whether advisers are looking at EIS and VCTs they should be doing ‘enhanced reporting’ and making sure their research and due diligence is ‘evidenced so they can show that [the recommendation] is appropriate’.
The FCA may not yet perceive due diligence on VCTs as a specific problem and are currently focusing on even more esoteric investment areas.
‘It may be that they don’t perceive a problem in the way that IFAs are approaching these tax-advantaged investment opportunities at the moment,’ says Glencross.
‘If there was a problem then they’d be breathing down your neck. Other areas are of more concern.’
In particular, Glencross says the regulator has been worried about crowdfunding.
‘They’ve had to recognise that they don’t want to be treading too heavily in something that’s the democratisation of funding for small companies,’ he says.
‘They’re far more concerned about other risks and misuse. If they’re not seeing [IFAs use products appropriately], they’ll maintain an appropriate level of scrutiny.’