The Association of Investment Companies examines the relentless popularity of VCTs
It has been a golden time for VCTs with near record fundraising in the 2017/18 tax year, with VCTs raising £728 million, the highest amount ever raised at the current 30% level of upfront tax relief. This is the second highest amount raised since the inception of VCTs and a 34% increase on last year’s figure of £542 million. This is a testament to the demand for VCTs from investors and follows hard on the heels of the government’s crucial recognition of VCTs as effective providers of patient capital in the November 2017 Budget. So what’s been driving this demand?
This year’s bumper fundraising was boosted by uncertainty about the government’s Patient Capital Review as there were rumours ahead of the Autumn Budget in 2017 that the Chancellor would change the tax reliefs on VCTs. Clearly some advisers made sure their clients subscribed for their VCT shares early to avoid any potential changes to tax reliefs. However, VCT fundraising remained robust after November when the government confirmed that VCTs’ tax benefits would remain in place and recognised VCTs’ important role in providing patient capital. The government also introduced some significant rule changes, which were mostly introduced on 6 April 2018 with some held back for 2019.
It’s clear that something more fundamental is going on with the increasing restrictions around pension contributions being a key driver of demand for VCTs. The significant changes to pension regulations, including the reduction of the lifetime allowance, are prompting many investors and their advisers to look for complementary investment solutions to plan for their retirement. Many who are comfortable with the risks of investing in small unlisted companies have turned to VCTs as a clear way to diversify their portfolios in a tax-efficient way. The tax regime for buy-to-let investments is also less favourable because of new limits on mortgage interest relief and higher rates of stamp duty, and again VCTs can provide an alternative for investors willing to take the risks.
It has been a golden time for VCTs with near record fundraising in the 2017/18 tax year, with VCTs raising £728 million
Contributing to the demand for VCTs is their strong longterm growth and income record. The average VCT is up 24% over three years, 55% over five years, and 112% over 10 years, an impressive record and clearly some sectors have performed better than others with the VCT Generalist sector up 21% over three years, 49% over five years, and 105% over 10 years. The tax-free yield is also vital for VCT investors with the average VCT yield being an attractive 7% in this low interest rate environment.
Many VCT investors recognise the benefit of VCT investment and expertise to smaller UK companies. VCT fundraising is vital to UK smaller companies as they will benefit from the VCT investment and expertise they need to grow. VCT-backed businesses deliver important economic benefits, with jobs more than doubling after VCT investment. VCTs target the SME finance gap, providing funding to smaller companies which are not well-served by traditional investors. 57% of smaller companies supported by VCTs received total investment of between £2 million and £10 million. The average level of investment received by small businesses was £3.2 million.
So will the golden age continue for VCTs? Managers are generally optimistic but expect returns could be more volatile as the new rules increase the risk scale because they eliminate the possibility of certain safer kinds of investment. Trevor Hope, Partner at Mobeus Equity Partners, said: ‘The outlook for the VCT sector is positive with growth capital required to provide support to SMEs as they navigate the uncertainties and opportunities which will be presented by Brexit. However, as investment strategies focus on earlier stage companies VCT funds and their shareholders must expect a greater volatility in returns.’
The reasons why demand has increased for VCTs remain in place and the UK’s smaller companies should continue to benefit from VCT investment and expertise
It’s also likely that the new rule requiring managers to invest money faster will increase managers’ caution over fundraising: raising too much, too quickly could make your performance suffer, and hence your reputation: no VCT manager wants that.
However, the reasons why demand has increased for VCTs remain in place and the UK’s smaller companies should continue to benefit from VCT investment and expertise. This is summarised by Jo Oliver, Fund Manager of the Octopus Titan VCT, which raised a record £200 million last tax year, who said: ‘There has never been a more exciting time for VCTs – it’s been a great fundraising season. Investor demand is rising for access to the growth potential of some of the UK’s most dynamic smaller companies, as well as the tax benefits that VCTs can offer.’
As for the golden time, we will have to see if King Midas continues to favour VCTs.
