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Is the venture capital trust sector heading for an all-time record?

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18 February 2019

With six weeks or so remaining of the 2018-19 tax year, David Prosser looks at VCTs and recent fundraising efforts.

Is the venture capital trust sector heading for an all-time record? With six weeks or so remaining of the 2018-19 tax year, VCTs are stepping up their funding campaigns – and if all of them hit their targets, the sector will have collectively raised around £850m over the full year.

That would represent a near 17 per cent increase on last year’s total of £728m, itself the second-best year ever for VCT fund-raising. It would also come in ahead of the record-setting 2005-06 tax year, when VCTs picked up £779m; that high was followed by a leaner period for the sector as the Treasury cut back on the tax incentives available through VCT investments.

There’s good reason to think 2018-19 will register a new peak, with six fund-raisings already having closed following buoyant demand from investors and their financial advisers. Many of the VCTs still open for new subscriptions are run by highly-regarded managers in the sector with a good track record on previous funds.

Moreover, the potential pool of investors for VCTs has been steadily increasing in recent years, as tough new rules on pension contributions have ensnared increasing numbers of savers.

The annual allowance on pension contributions of £40,000 is small compared to the £200,000 yearly limit on VCT investment. Moreover, higher earners get a reduced pensions allowance – potentially as little as £10,000 – which gives many even more reason to consider other tax-efficient investment products. Add in the effect of the lifetime allowance on pension savings – which hits pension funds worth more than £1.03m with punitive charges – and you can see why more people are looking for other alternatives for long-term savings.

One option, of course, for savers worried about the pension caps is the £20,000 annual individual savings account (Isa) allowance. But once they’ve used that, VCTs are one of the few tax-efficient opportunities remaining.

The incentives are certainly alluring. Investors get 30 per cent upfront income tax relief on investments in newly-issued VCT shares, though they must then hold on to the stock for five years to keep the relief. In addition, both income and capital gains from a VCT are tax-free.

That support is available because the Government is keen to encourage investors to fund the type of company that VCTs must back. The funds must hold 70 per cent of their assets in early-stage, small-scale enterprises that are privately owned (or listed on the Alternative Investment Market). Indeed, the rules have been tweaked in recent years to sharpen this focus.

Such businesses are naturally higher risk, with greater chance of short-term volatility or even outright failure. On the other hand, VCTs invest in a portfolio of companies, offering diversification to mitigate the risk. Plus they’re typically managed by specialists in the start-up and scale-up market, rather than the managers employed by most investment companies to pick quoted shares.

Still, advisers and investors will need to choose their funds carefully, with a range of different VCTs available, from generalist funds to those specialising in particular sectors or companies of a certain size. There is no requirement to invest in only one VCT – a portfolio of funds, subject to the overall £200,000 limit, might make sense for some investors.

One final thought: some in the VCT industry are beginning to worry that the funds’ popularity might attract the unwanted attention of the Treasury. If we do hit a new record this year, the Chancellor might be tempted to cut back on the tax incentives available, just as his predecessor did 15 years or so again. Still, that would almost certainly apply only to future VCT issues, rather than to existing investments.

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