MoneyMagpie

Feb 19

How to invest in VCTs

Venture Capital Trusts (VCTs) are the sort of thing that seasoned investors might consider putting money into. They’re not for everyone by any means, but for a few – particularly those who are willing to take a punt and want to save tax – they might be worth a go. Here’s our guide to investing in VCTs, and whether it’s a good idea for you.

What are VCTs?

VCTs stand for Venture Capital Trusts. They’re a type of investment company — and one of the riskiest types at that! They’re pretty similar to investment trusts, and they’re all listed on the stock exchange, but they focus their investments on very young companies called start ups.

So why bother with VCTs?

Well, start ups can, occasionally, do amazingly well — just think of Facebook or Google — and the people who invested in those sorts of companies early on made a vast amount of money.

The other interesting thing about VCTs is that the UK government offers major tax breaks on any money you earn — currently 40%, even if you’re not in a high tax bracket. These exemptions are designed to encourage investment in young companies — (the idea behind this government policy is that greater investment will help spur on the development and growth of the next generation’s innovative companies; and if the government did not offer such a tempting tax exemption, the fear would be that not enough people would ever take the risk of investing in these companies, and potentially exciting new start ups would wither.)

 

But remember – there are big downsides!

The tax reductions may make VCTs seem like a glittering investment, and it is always exciting to be helping to fuel the ‘next generation of innovation’, but with each tempting tax incentive comes a high degree of risk:

  1. VCTs can only invest in small private companies, plus those listed on the Alternative Investment Market (AIM) and OFEX (where many small companies begin their lives as publicly listed companies). These may have the chance to boom, but they have have a higher chance of going bust.
  2. You have to keep the investment for three years or face losing the tax break — so there is no ejector seat if the share values start to plummet.
  3. Management charges for VCTs are much higher than for most other investment funds. The difficulty of spotting which companies will be successful at such an early stage requires a great deal of experience and expertise, and that means you have to pay VCT managers more for their services.There’s often an initial charge of around five per cent, while management fees are normally between 3 and 4 per cent. There are also frequently performance fees – so if certain targets are hit, these fees can all but wipe out the tax relief VCTs benefit from. Compare that with the fees that are charged by standard trackers or Exchange Traded Funds (around 0.5 per cent). Even actively managed funds only charge around 1.5 per cent. There are potential rewards with VCTs, but Exchange Traded Funds overall are normally a far better bet.
  4. VCTs also have a poor investment track record. Their poor reputation of making money in the long run leaves other investors reluctant to buy them. These sorts of shares are known as illiquid, meaning they are hard shares to sell quickly.

 

Yet still!

They are becoming increasingly useful when it comes to pension holdings. As the amount of tax free money that can be held in pensions is reduced, people are increasingly looking for tax savings through VCTs

But the performance of most of them has been pretty disappointing. So make sure you do your research before putting money into them, and do bear in mind that old investment adage: don’t let the tax tail wag the investment dog.

More info about VCTs can be found at Trustnet and the Tax Efficient Review.

How do you invest in VCTs?

If you are still keen on VCTs, then there are two main ways to go about it:

  1. Through financial advisors.
  2. Through stockbrokers.

moneymagpie_tradingDue to UK financial regulations in the UK, which are in place to ensure legal financial practice, it’s impossible for people to invest directly in VCTs without the relevant financial qualifications (i.e. you need to be a qualified financial advisor or a stockbroker).

If you speak to an advisor they will give you a number of choices for the type of VCTs you could invest in. The three main choices include:

1) Alternative Investment Market (Aim) VCTs. These VCTs are a selection of companies your financial adviser or stockbroker cherry-picks from the Aim — a submarket restricted to small companies on the London Stock Exchange.

2) Generalist VCTs. These VCTs are the ones invested in unquoted companies from a wide range of sectors. Unfortunately generalist VCTs are particularly difficult to sell, since they are unquoted, which means there is no secondary market for them.

3) Specialist VCTs. These are the VCTs that you invest in a particular sector — for example, the biotech or media industry.

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