Why VCTs remain a compelling opportunity

The Association of Investment Companies (AIC) is campaigning for the government to reverse this cut in the upcoming Budget, since it risks reducing VCT fundraising and therefore depriving high-growth companies of opportunities to scale up and power economic growth. 

As the AIC reported this week, VCTs have been busily deploying the capital they have into nascent UK tech companies to help them grow and expand, illustrating their value in helping these companies reach their full potential.

There are reasons to think that the drop in fundraising might not be quite as bad as it was in 2007 when the relief was cut from 40% to 30%. 

One important difference between now and 2007 is there are fewer tax-efficient investment opportunities available – particularly to wealthier and more experienced investors to whom VCTs are most likely to appeal. 

Tax breaks on private pensions, for example, are no longer so generous. The individual savings account (ISA) allowance hasn’t been raised in years. Capital gains tax allowances have been reduced while tax rates have gone up. Dividend tax has gone up too. 

In this context, VCTs continue to stand out. In addition to a generous slug of upfront income tax relief – still valuable even after April’s cut – investors get tax-free income and capital gains from VCTs. These tax breaks acknowledge the importance of incentivising investment in the small, early-stage companies in which VCTs invest.

However, VCTs aren’t just a tax play. Indeed, VCT managers are keen to make the investment case for their funds, even leaving aside the tax breaks on offer. Not least, these funds offer one of the few opportunities for retail investors to secure exposure to privately owned technology businesses – including the UK’s most exciting artificial intelligence firms. 

As the forthcoming Anthropic IPO in the US illustrates, these companies often only come to public markets once they achieve huge scale; but retail investors can’t usually get in early, while they’re still private. Investment trusts and VCTs provide some of the only routes into these exciting companies whilst they are still privately owned. 

Another part of this story is VCTs’ phenomenal record on income. The businesses in VCT portfolios are generally too early-stage to pay dividends, but VCT managers often structure their funds in a way that enables them to pay out the proceeds of successful investments via income distributions.

Research published by the broker Chelsea Financial Services in recent days shows just how valuable this can be. It looked at the ten-year track records of 29 VCTs from mid-2016 to the present day; 13 of these funds have returned at least 70% of their mid-2016 net asset value (NAV) through dividends over the period. Several have also combined substantial income with growth in NAV.

In other words, the best VCTs have been able to pay out 70% of their mid-2016 value in tax-free income, while still maintaining, or even increasing the capital value. Alternatively, investors have had the option of reinvesting their income, super-charging the value of their VCT holdings.

None of which is to suggest VCTs are a sure thing. These funds offer exposure to young businesses that may never make the grade – though recent changes in the rules, introduced alongside the tax reforms, enable VCTs to hold larger businesses than in the past. And not every VCT has a track record that’s up there with the best.

Still, for investors looking beyond pensions and ISAs for tax-efficient opportunities, VCTs remain highly attractive, even after April’s changes. But think of these funds in terms of the investment opportunity – the chance to get into exciting growth businesses at a much earlier stage than is usually possible – rather than just as a tax planning strategy. 

The tax relief is the icing on the cake, but for investors making a considered choice to embrace the elevated risk-reward profile of VCTs, the size of the upfront sweetener shouldn’t be the primary consideration.