By Ewan MacKinnon, partner at Maven Capital Partners
The Chancellor’s recent announcement of an extension to the sunset clause for VCTs to 2035, as part of the 2023 Autumn Statement, was welcomed by small businesses and investors alike. For early-stage SMEs, this has provided much-needed reassurance over the availability of a crucial source of growth finance, with the challenging economic outlook making fundraising more difficult.
For investors, the extension of the sunset clause has confirmed the role of VCTs going forward, having become a firmly established part of regular financial planning. The favourable tax regime, robust returns history and role in diversifying investors’ portfolios are key attractions.
However, the past record and potential returns of VCTs will of course be balanced against the other tax-efficient investment options available, particularly in times of high interest rates, and the importance of avoiding overexposure to and having a diverse portfolio. Investors should therefore be comfortable with how VCTs complement their portfolio and investment objectives.
VCTs moving into the mainstream
As a long-term investment, VCTs offer returns that are typically uncorrelated to wider main market trends, which partly explains why VCTs have raised £1bn annually since 2021 despite some serious economic turbulence. In the 10 years to September 2023, the 10 largest VCT managers delivered an average NAV total return of 81.4%, outperforming the London Stock Exchange Main market.
The annual amount invested into VCTs has more than doubled since 2017, when the VCTA began tracking this data. Indeed, the past few years have seen VCT investment becoming a standard fixture of portfolios, and a staple of retirement saving strategies. According to a survey conducted by the Association of Investment Companies, 60% of respondents used VCTs as a way to save for retirement.
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There are other options for retail investors to access significant tax reliefs beyond the investment limitations of ISAs in 2024, with pensions being the highest profile alternative. However, although the Government’s pensions allowances changes in March 2023 did increase the cap on the tax-free allowance on annual pensions contributions and remove the cap on lifetime contributions, the tapered annual allowance increase is marginal enough that VCTs remain a convincing option for investors seeking diversification. While the headline rate of tax relief offered by VCTs is lower than for high earners could achieve through pensions contributions, VCTs also provide tax-free dividends and the ability to withdraw the funds after five years to reinvest.
Investors must be prepared for risk
Of course, there is an element of risk in investing in VCTs, with their reliance on the performance of early-stage businesses. Smaller companies are more likely to fail than established, financially stable ones, and can take longer to scale. Some VCTs can be volatile investments, especially in the short term if a VCT has a small portfolio. They are therefore best used as part of a diverse portfolio, complementing existing assets, to access a range of high-growth, early-stage companies across various sectors.
Diversification will be a popular theme in 2024, helping investors hedge against economic uncertainty. In making their VCT investment choices, particularly given the current economic backdrop, investors should consider VCTs that focus on businesses with strong defensive characteristics and benefit from a recurring, contractual revenue base. Experienced VCT managers are more likely to have a diverse portfolio of investments and are better placed to adapt to changing market conditions, though investors should always conduct thorough due diligence when selecting a VCT.
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VCTs are therefore likely to be rewarding for investors over the long term and investors should be looking at a holding period of at least five years in order to retain the income tax relief. It will also generally take several years for companies that VCTs invest in to achieve profitability and their success will often depend on their ability to adapt and innovate.
Boosting British businesses
The period since 2008 demonstrates the critical role played by VCTs, both in boosting the returns of investors’ portfolios and in fuelling economic recovery. After the Global Financial Crisis, capital was scarce, and access to bank credit was restricted by a raft of new regulations. But investors who had committed capital to VCTs during this period saw strong returns, as the sector helped create new companies that have now become household names, such as Gousto and Zoopla.
Similarly, the current economic climate favours the kind of high growth early-stage SMEs that VCTs typically target. A large pool of talent in the technology sector, following rounds of redundancies, as well as Government support to boost the UK’s science and technology sectors, mean that such disruptive companies are well-placed to succeed, and drive returns for investors.
VCTs give investors a chance to contribute to innovation, job creation and the wider British economy, through an efficient tax-vehicle. A well-resourced VCT manager can help mitigate portfolio risks for investors and provide strong investment opportunities and returns.
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