ALERT - VCT INVESTMENT RISK

It is important to be aware of the general risks when considering investing in VCTs. Here we set out some points to keep in mind.

Manager Risk

We feel that it is important to focus on the track record and the experience of the fund manager. If there appears to you to be not sufficient weight of experience of investing in the AIM sector or smaller companies in general, and it is an AIM VCT for example, then you may wish to consider one where pedigree is more to your liking. A reassuring point in respect of VCTs is that they are publicly quoted companies with an independent Board of Directors – also, before being allowed to launch a VCT, the fund manager is subject to a careful vetting procedure by the Financial Services Authority. Only those managers with sufficient track records of managing similar funds in the past will be given permission to launch a VCT.

Unquoted Companies

VCTs invest in unquoted or AIM listed companies. These companies, individually, carry an above average level of risk. The benefit of investing in a VCT is that you gain access to a portfolio of these companies - often 50 or more such enterprises – so the risk is diversified. Also, fund managers will usually take a board seat and will be able to exert influence over the management and their stake. This helps the fund manager to monitor his investment and to make changes if he needs to.

Market Timing Risk

Another difference of a VCT compared to a traditional fund is that the former will usually invest gradually over time. Unlike a unit trust which must be 90% invested at all times, a VCT can spend up to three years investing client’s capital. This means that the majority of the fund over the first year will remain largely in cash, earning interest on behalf of the investors. This allows the fund manager to benefit from the quality that is so important in fund management – patience. The VCT manager will only buy shares when he sees an opportunity to outperform cash.

Fund Size

One of the main risks in backing a VCT is picking a fund that is too small (less than say £10 million). You must make sure when considering investment into a VCT that the fund is sufficiently large to enable proper portfolio diversification. Also consider that if a VCT fails to attract a minimum level of subscriptions – often £1 million, then investors’ applications will be returned to them. This introduces the possibility of failing to obtain VCT tax relief within the current tax year, if time does not permit application elsewhere.

Liquidity Issues

One of the main problems with VCTs has been the lack of potential exit for the investor (through a sale of shares in the market) or insufficient return of capital via tax-free distributions.
Sale of shares in a VCT: Although VCTs are listed on the main market of the London Stock Exchange, there is very little liquidity as purchasers of VCTs in the secondary market do not receive the 30% income tax relief. Some funds do not address this problem and allow the shares to trade at a very significant discount to Net Asset Value ("NAV"). A number of managers have implemented a share buyback policy whereby the manager will buy back shares at a small (typically up to 10%) discount to NAV. To do this, the manager retains a certain % (generally up to 20%) of the fund's assets in cash or near cash assets (i.e. if the fund was fully invested, there would be no funds to undertake buybacks).
Distributions to Investors: It’s important that investors focus on VCTs that are backing businesses that are not too early stage. The time to sale of early stage investments is not consistent with the return expectations of most investors. That’s why most investors tend to look for VCTs that are investing in development capital (i.e. later stage venture capital) with perhaps just a small exposure to early stage enterprises.

Specific Risk Warnings

No one should invest into a VCT without first reading the mini prospectus of the Offer being made. The section headed “Risk Warnings” of each prospectus should be examined carefully. Other items to look for are – initial costs of issue; annual management fees; annual running costs and are they capped; performance fees; declared exit strategy for investors; the amounts of capital the Managers of the VCT are investing from their own money into the VCT. Above all, a VCT is not a short-term investment. Early realisation is to be avoided unless there are sound reasons for encashing after at least 5 years has elapsed. They are best viewed as an investment to be held over 5 to 7 years and longer.

For details of VCTs that meet our research criteria and that we commend for your consideration call us or go to the Enquiry Form.