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Will VCTs continue to have a role in investors’ portfolios?

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3 December 2015

David Prosser looks at the new changes to VCT rules and their role in investors’ portfolios.

No news is good news, you might say. Last week’s Autumn Statement from the Chancellor largely passed without incident for the investment industry, though the decision to freeze the Isa allowance in April will no doubt be mourned by fund managers and financial advisers alike.

Otherwise, the only change of any note from George Osborne concerned venture capital trusts (VCTs), where any company involved in energy generation will henceforth be excluded from the list of permissible investments for these funds. This follows a similar measure announced in July’s emergency budget, which saw renewable energy businesses struck off the list.

This is not to say, however, that VCTs are otherwise to be left unchanged. Earlier this year, Mr Osborne announced changes to the rules in order to prevent the funds contravening the European Union’s laws on state aid. VCTs will no longer be allowed to invest in companies that are more than seven years old, or those that have more than 250 employees; investments of more than £12m in any single company will also be off-limits.

This will make VCTs a different proposition for investors in years to come. Effectively, the changes increase the risk profile of VCT investment – funds’ portfolios will in future consist of younger and smaller business, with which higher rates of failure are typically associated.

For some advisers and investors, this may actually add to the attractions of the sector – VCTs were, after all, originally launched to promote investment in businesses that might otherwise struggle to attract backing, with the high risk and reward profile of such enterprises a key part of the allure for many.

For others, however, the changes may be less welcome. For example, businesses of this nature are less likely to be able to pay dividend income to shareholders, which may be off-putting for income-seeking investors.

Having said that, the changes won’t affect all VCT investments in quite the same way. While managers raising top-up funds for existing VCTs will be bound by the same rules, the new qualifying companies they add to their portfolios will represent only a minority of their holdings for some time to come. By contrast, brand new VCTs will be putting all their money into such businesses – or at least the 70 per cent of assets that a fund must eventually invest.

This should give advisers pause for thought. Those whose clients are attracted to funds offering potentially higher risks and rewards will naturally gravitate towards completely new launches. Other advisers will feel more comfortable with top-ups from existing VCTs.

Either way, the generous tax incentives on offer from VCTs aren’t changing. Investors will still get upfront income tax relief of 30 per cent on their stakes, and continue to qualify for tax-free income and profits. These generous perks will mitigate some of the risks of investing, even in the new environment.

We’ll see over the next few months how VCT managers respond to the changes – there have been predictions that this year’s fund-raising efforts will be muted compared to 2014-15. However, there is every reason to be confident VCTs will continue to have a role to play in the portfolios of many investors – particularly given the move towards less generous tax incentives for pension savers, especially at the top end.