A compelling proposition

As venture capital trusts celebrate their 25^th birthday, one specialist adviser on these funds says its clients have been investing at a rate of £76,000 an hour in recent weeks. It’s a reminder that VCTs, launched by the then Chancellor Ken Clarke (what happened to him?) in his November 1994 budget, have never been more popular.

It’s not difficult to see why. These closed-ended funds provide a range of attractive tax breaks to investors prepared for the risks of exposure to small, early-stage businesses. The funds offer 30 per cent upfront tax relief on investments in new shares as well as tax-free income and capital gains, and you can invest up to £200,000 in any one tax year.

Moreover, while those reliefs look generous at the best of times, they feel particularly valuable at a time when many higher earners and wealthier savers are running out of room to make tax-efficient pension contributions. With the annual allowance on pension contributions now reduced from £40,000 to as little as £10,000 for the highest earning savers, the number of investors subscribing for VCT shares has risen 40 per cent over the past couple of years.

One critical feature of VCTs is that investors don’t get the upfront tax relief on purchases of shares in the secondary market; only newly issued shares qualify. This has led to an annual fund-raising round, typically beginning in the autumn, where VCT managers either launch top-up share issues for their existing funds or offer brand new funds.

This year has been no exception. The Wealth Club, the adviser mentioned above, currently lists no fewer than 17 VCTs raising money. That there is so much choice is good news for investors – and especially those with access to expert independent financial advice on the sector. The offers include generalist VCTs from managers with a strong track record, a number of funds focused on the Alternative Investment Market, and several specialist vehicles. There are therefore options for those investors coming to VCTs for the first time as well as those with experience of the funds who now want to build diversification into their portfolios.

Advisers will recognise, of course, that there is no such thing as a free lunch. VCTs have produced some high-profile success stories, supporting businesses such as the retailer GO Outdoors and the restaurant chain Five Guys, but there have also been setbacks. These are inevitable with investments in the smallest businesses and some funds have racked up capital losses.

Against that, however, the combination of upfront tax relief and tax-free dividends offers a reassuring cushion against losses. Even those funds that have generated negative investment returns in recent years look much more rewarding once you factor in the income streams they’ve produced, let alone the fact that investors were effectively 30 per cent up the moment they invested.

Looking forward, the question is how long VCTs will survive in their current form. The sector has frequently been tipped as a target for Treasury ministers looking to save money and the more popular it becomes, the more it will move on to the radar of the Chancellor. Still, for now at least, VCTs remain a compelling proposition – clearly, not for all investors, but certainly for those looking beyond pensions for additional forms of tax-efficient savings.