Over the next three months, you will see a large number of advertisements extolling the virtues of a variety of VCT funds and in almost every case, they will stress the highly attractive tax reliefs provided to investors. Whilst many investors already have knowledge of these creatures,  some private investors are less familiar with them and, the rules having recently changed, we feel it would be useful to provided a short note about them NOW. As independent investment managers we stress that this note covers VCTs in general and makes assertions about the VCT market after considering the full range of available funds. It does not purport to give specific tax advice which individuals should seek from their usual tax adviser. Having read this note you should know the questions that should be asked before deciding if VCTs are remotely applicable to you and if they are, you might have a better idea of the specific type of funds that would be suitable.  (We make no attempt to recommend specific funds here as such advice depends wholly on individual circumstances and attitudes.)

BEFORE READING ANY FURTHER, PLEASE ASK YOURSELF 4 QUESTIONS:

· Does it make a big difference to my state of mind if an individual investment loses value?

· Would it matter to me if the returns from my investment took 10 years to accrue?

· Is it likely that I will need access to some of my capital within 5 years?

· Do I expect to pay little or no UK Income Tax ?

YOU MAY DISCARD THIS NOTE IF ANY ANSWER THUS FAR IS “YES”!

Now consider these statements:

· I have adequate income and I already have bond, equity, cash and property holdings.

· I have adequate existing pension arrangements currently in force.

· I expect to pay a large amount of Income Tax.

· In life, to obtain modestly higher returns one must accept modestly higher risk.

IF YOU AGREE WITH THESE STATEMENTS….. READ ON

WHAT ARE VCTs?

In a nutshell, for 20 years, the Treasury has offered  tax incentives to private investors who provide ‘risk capital’ for small companies.  Whilst the rules have changed constantly, the basic equation has remained that in return for investing in small businesses, investors have received income tax rebates on sums invested.  To this extent, VCTs are nothing new but until April 2006, tax relief has been raised to 40% whilst dividends paid out of VCTs remain free of Income Tax and profits made on disposal remain free of  Capital Gains Tax.  Investments must be held for no less than three years and VCTs may only invest in new shares issued by unquoted companies, or companies quoted on the AIM that are valued at less than £15m. VCT managers are prevented from investing in finance or property companies – although some trading properties (notably managed pubs) ARE allowed. 

WHAT AREN’T VCTs?

VCTs are NOT unit trusts and there is little realistic likelihood that there will ever be a sensible market in VCT shares once they are purchased.  (Shares in well known Investment Trusts such as Foreign & Colonial often trade at discounts of more than 10% to asset value. In the case of VCTs where the underlying assets may well be unquoted, share prices can often show a 30% - 50% discount to asset value – or more!). In practice therefore, investors should expect to hold on to VCT shares for at least 7 to 10 years and recieve occasional payouts as underlying investments are sold or taken-over. Whilst not remotely a disadvantage, it is also worth noting that VCTs are most unlikely to move in line with the rest of the stock market as their underlying investments are potentially much more volatile (in either direction) than more mainstream equity investments.

WHAT SORT OF VCT INVESTMENTS ARE AVAILABLE?

With VCTs, we believe that the ability to read a balance sheet will prove less important than with conventional quoted stocks which are the bread and butter of conventional fund managers.  The successful VCT manager must use eyes and ears to make sensible judgements not only on the company, but on the personalities of the management.  No degree or MBA confers this gift and consequently we do not believe that conventional fund management houses will necessarily be the best managers of VCTs.  Nonetheless, as the stock market in general has been less than exciting in recent years and Investment Managers are looking for new ways to market their skills, the high level of headline tax relief available on VCT investments has acted like honey to a swarm of bees.  Many companies (including such well-known names as Invesco, Framlington, Artemis) have concluded that the new rules provide them with an opportunity to provide further work for their Smaller Companies teams to scour  the companies available on the AIM (the entry-level compartment for the main London Stock Exchange).  Whilst these VCTs may have the largest advertising budgets, for the reasons stated above we actually believe that they might well be the least efficient sort of VCT investment. There will be several managers with wads of other people’s cash looking to invest in the small number of good companies that are quoted on AIM and yet are still valued at less than £15m. We therefore suspect that the performance of these funds will owe an even larger amount to luck than normal.

Other funds are more sophisticated in that they are looking to invest in unquoted companies which are naturally much more abundant than qualifying AIM companies, but which naturally carry a greater range of activities and risk ratings.  Companies such as Close Brothers, Electra, Northern Venture Managers and Matrix, are used to investing in unquoted companies, management buy-outs and other such opportunities and have historically done pretty well.  With a 40% “discount” available on new purchases in any case, we believe that these funds offer a more stimulating investment – as well as a better potential return. 

Finally, there are a small number of hyper-specialist funds looking in very specific industries or geographic areas.  These are generally managed by specialists in certain fields (eg medical applications) and offer the highest potential return – but of course the highest risk. 

CONCLUSION

As a final point however, whilst we naturally wish to be clear about the potential risks of VCTs, we would also like to be clear that VCTs are by their very nature diversified assets and therefore offer greatly reduced risk when compared to investing in a single modest sized company, quoted or otherwise. Whilst risk is a major factor in VCTs, it is worth remembering that after allowing for tax relief, 40% of the underlying holdings can become utterly worthless before the investor loses any capital at all. We therefore believe that these Trusts merit serious consideration by more sophisticated investors who are content to accept tax relief in lieu of any short term returns and retain the expectaion of a stream of future dividends into the next decade instead of a single disposal point. 

Clearly the choice of fund that best suits you requires in depth consideration and whilst VCTs are not suitable for inclusion within a Discretionary Managed portfolio at BAM, we would be delighted to discuss the merits of competing VCTs on an individual basis. We would also be happy to talk with professional advisers who might wish to discuss VCTs in depth to assess their suitability for their own clients.  In either case, please telephone Hugo Pring, or email hugo.pring@borderam.com.

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