Is now the time to buy VCTs?

Should you buy now while stocks last with venture capital trusts (VCTs)? Many investors and advisers wait until towards the end of the tax year to make their annual VCT selection – but experts are warning that some of the best funds may no longer be available by the time we get into February and March of 2023.

Remember, VCTs offer a range of generous perks, including tax-free income and capital gains, and upfront income tax relief on your initial investment. However, this latter benefit is only available on investments in new VCT shares; this means that VCT managers launch new share issues each tax year, either raising more money for an existing fund, or (less commonly) launching an entirely new vehicle.

Since there are strict rules requiring VCT managers to invest most of the money raised within a set period, it’s important they don’t end up with too much cash on their hands. Otherwise, there’s a risk that they rush into inferior investments simply to stay within the rules. This danger is especially acute this year because last year was a record period for VCT fundraising.

As a result, the supply of VCTs in the 2022-23 tax year may be a little more constrained than in the past. Some managers may opt to limit their fundraising at lower levels than previously; others may choose not to issue new shares at all.

Meanwhile, there are pressures on the demand side too. With pension contribution allowances effectively frozen for the foreseeable future – and no sign of any further increases to the ISA allowance – investors are growing short of tax-efficient homes for their money. VCTs, with the annual £200,000 investment limit, are the most generous option remaining.

The overall effect could be a squeeze on the VCT market that leaves some investors locked out of the funds they really want to back. Certainly, a number of funds already launched this tax year have sold very quickly. Two Octopus funds launched in September reached their fund-raising targets by mid-October. Funds from Mobeus and Hargreave Hale also look set to hit capacity within a few weeks of launch.

In which case, investors and advisers who tend to leave it late when choosing VCTs may want to get a move on.

There are other reasons to consider buying VCT shares early in the season too. First, a number of managers offer “early bird discounts” – the first investors to commit themselves pay a reduced initial charge to get into the fund. In addition, investors may be able to claim their upfront tax relief more quickly – possibly even through the pay-as-you-earn tax system.

For all that, the old saying about not letting the tax tail wag the investment dog still applies. Investment decisions made purely for tax reasons don’t always work out brilliantly – the same is true, for that matter, of choices made simply on the basis of charges.

In other words, investors should not rush into making a decision about VCTs – buying hastily to beat the queues is not sensible financial planning. However, for advisers and investors for whom VCTs are definitely on the agenda in the current tax year, it’s a good idea to start focusing on them sooner rather than later.