Where Do the Opportunities Lie for VCT Investors in 2016?

Technology VCTs were the best performing in 2015, with impressive average gains of 26%. Where do the risks and opportunities lie for the year ahead?

Karen Kwok 4 February, 2016 | 5:52PM
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Investors in venture capital trusts last year saw investments rise an average of 9%, whilst fundraising inflows reached £429 million, the fourth highest year on record. VCTs met investors’ demands for income, with an average yield of 8.6% across all trusts at the end of the year.

Technology VCTs were the best performing in 2015, with impressive average gains of 26%. The generalist sector also made good gains with an average return of 10%, according to the Association of Investment Companies.

Stuart Veale, of ProVen VCTs said that positive performance was driven by a number of companies with the digital media and online retail sectors.

“Disruptive technology is fast growing, online platforms are replacing physical contact with customers,” he noted. “Private investors are turning to VCTs in ever greater numbers, attracted by the sector’s strong historic performance, including regular tax-free income, enhanced by the initial 30% income tax relief.”

Potential in Consumer-Based Technology Businesses

Veale was not the only investor to spot the potential in technology-related businesses. Tom Thorp, director of the Foresight Group said consumer-facing technology was an area the company would be looking to invest in. Software services, for example, is a sector full of potential he said.

“Small and medium-sized enterprises now want to build their own apps so they can control their own online presence rather than build websites. SMEs can go now online in minutes and gain exposure to a wide range of audiences, gaining tangible return in a “cost-effective” way,” he concluded.

Is Brexit a Risk to Future Returns?

A referendum on whether the U.K. should leave the EU or leave, so-called Brexit, is widely expected to be held in June this year. Paul Jourdan, manager of Amati VCTs, thinks that even the UK leaves the EU, the consequences will be moderate, and it will not prohibit foreign businesses investing in the UK.

"We continue to see it as a low probability that we leave the EU.  However, as far as the VCT legislation is concerned, which has been heavily reshaped by Brussels in 2015, I think it is wrong to expect that a vote in favour of Brexit would mean that the difficult aspects of the new rules would be unwound.  It may happen that way, but I doubt a future UK Government would want to into enter a dispute with EU trading partners over this particular legislation," Jourdan said.

Jourdan said that UK was still a great investing environment for investors and entrepreneurs.

“I can’t think of anywhere better than the UK for investing in growth companies. And a good growth company will lead to a better return for investors,” he concluded.

Focus Switch to Capital Growth Investment

Under the new rules, VCTs will no longer be able to invest in management buy-outs, a transaction where a company’s management team purchases the assets and operations of the business they manage.

Jourdan said that while management buy-out businesses would be affected, investors should not be worried as the new rules would not affect them and the products remain simple for the user.

Tom Thorp, Director of Foresight Group thinks the change will bring a healthy balance to VCT investments’ portfolio.

“Capital growth often has a steeper growth curve than a management buy-out. When you bring more growth capital opportunities in the portfolio, you are spreading the risk across a large number of companies,” he said. “So for investors’ perspectives, for dividend potential it could be greater, because you do have that blended growth capital deals in your portfolio.”

Investors – Be Wary of Risk

While the high returns on offer are attractive, investors should keep in mind that VCTs are a high risk investment product because of the nature of the companies they invest in. Micro-cap businesses and start-ups are more likely to default then their larger company peers.

Similar returns are achievable by investing in the UK smaller companies investment trust sector, with less volatility – although without the tax benefits. The top 20 UK small companies closed-end funds have an average 9% annualised five years return. Top performer Oryx International Growth (OIG), for example, has a 21% annualised five year return, according to Morningstar Direct Data.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Karen Kwok

Karen Kwok  is a Reporter for Morningstar.co.uk