VCTs - next scandal or gamble?

Dont consider investing in a Venture Capital Trust (VCT) unless you have a professional poker player's attitude to losing money, are prepared to forget about any return for several years and can face with equanimity the generally high charges levied!

Ah, but the tax breaks! Yes, they may be compelling, but then they need to be to encourage such high risk investing. Venture Capital Trusts are definitely for the risk-aware, not for those of limited means looking for steady safe growth or a guaranteed income.

The tax relief was doubled for the last financial year and the same rate applies again for 2005/6 investors. In essence you can put up to £200,000 (minimum £1,000) into VCTs and, provided you have initially paid sufficient tax, receive 40% in relief. So spouses could invest £400,000 at an effective cost of £240,000.

You must hold investments for three years to qualify for the tax privileges. There is also freedom from tax on any dividends paid and no capital gains tax due on the sale of VCT shares.

Venture Capital Trusts are listed companies quoted on the London Stock Exchange. They have raised around £1.7 billion since the concept was launched in 1995 as a way of encouraging investment in young, small companies and entrepreneurial ventures. Basically there are three categories: private equity (usually lower risk opportunities and MBOs); qualifying businesses on the Alternative Investment Market (AIM); and high risk opportunities.

The doubling of tax relief proved the investing equivalent of a 10% solution, raising 2003/4's dismal performance of £70 million (compared to the previous high of £433 million in 2000/1) to an impressive, record £521 million. Of this sum, about £9 million was raised at the start of the financial year when products launched in 2003/4 were immediately re-opened under the new tax rules (Allenbridge, Tax Shelter).

The regulators are starting to worry

This stampede to buy Venture Capital Trusts, around £750 million is expected to be generated this year, perhaps more if the Chancellor announces the end of the 40% tax relief, is giving cause for concern in regulatory quarters.

The Financial Services Authority is worried that VCTs are being promoted on the basis of the tax perks alone and people of relatively modest means are being targeted, saying, "We're keen to make sure this doesn't turn into the next mis-selling scandal ... [they are] inherently high risk products and investors may get back less than they invested."

This is very true. It is recognised there is a huge gulf between the best and worst VCTs, but Allenbridge notes that most of 2004/5's money went to the tried and trusted, for example Close Brothers Income and Growth (£45 million), Eclipse and Baronsmead.

Some VCTs didn't raise enough money and had to withdraw; others are still going ahead with as little as £1 million funding. A low level of investment means the fixed costs of running a fund are spread among fewer investors, potentially eating away at any dividend.

Tax Efficient Review recommends that investors do not put money into a VCT until it has raised a minimum of £10 million. It is vital to do research and to focus on management with a creditable track record. Think long term a minimum of five years, possibly 10.

A generalist VCT (range of unquoted companies in different sectors) such as Close, rather than a specialised one, is deemed the better option for first time investors. If you are sufficiently well-heeled with a pocket-money allowance of £200,000 then you may consider spreading it across several VCTs, split 60% generalist, 30% AIM and 10% specialist.

Note, though, that of the 75 VCTs launched in the past nine years, investors in 22 of them are facing losses!

01 July 2005 © Moneyextra.com

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