VCT Sept 2022

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Manager video content

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DR REUBEN WILCOCK

HEAD OF VENTURES

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5. Managers in Focus

BlackfinchOctopus InvestmentsVCT solutions comparison table

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Revenue reserve: how VCTs pay dividends in good times and bad

The Covid-19 pandemic led to a significant drop in business revenues, causing many UK-listed companies to announce suspensions, omissions or cuts to their dividend payments.

However, as reported in the following excerpt from the Investment Trust Dividend Monitor, by the Link Group, investors in Venture Capital Trusts (VCTs) were spared the worst of the dividend drought.

Because of their ability to set aside revenue reserves in good times to distribute when the going gets tough, most VCTs were able to continue paying dividends even at the height of the pandemic when lockdowns decimated businesses across most sectors.

By the end of March 2022, UK dividends had rebounded by a third in the twelve previous months, but had not recovered their pre-pandemic highs, according to the UK Dividend Monitor.

Revenue reserves by venture capital trusts, which fell by 6.8% in 2021, are starting to build up again. Going into the post-Covid era, VCTs seem well positioned to continue rewarding investors with attractive dividends.

5%

in dividend yield is equivalent to a taxable yield of around 8% for an additional-rate taxpayer

An effective protection from dividend drought

DISTRIBUTION OF THE PROPORTION OF INVESTORS CLAIMING VCT RELIEF BY SIZE OF INVESTMENT, 2018-19 TO 2019-20

The revenue reserve explains why investment trust dividends proved so resistant to the effects of Covid-19 that so badly infected dividends from the companies around the world making goods and providing services in which trusts invest.

By tucking away a portion of the dividends a trust earns each year, in bad times it can release this cash and shield its investors from cuts in the dividends it receives. This smooths out short-term fluctuations and provides a steadier, more reliable income to its shareholders.

Trusts drew on their reserves through the pandemic, but they also took advantage of special rules that permit them to distribute some of their capital gains as dividends. In our last edition, we reported that reserves had fallen by one sixth. The decline in reserves has slowed markedly.

Since last June (based on latest available accounts) they have fallen by a further 6.8% and we judge that trusts are likely to start rebuilding reserves from here on.

2018-19

2019-20

Investment band

£150,000 to £200,000£100,000 to £150,000£75,000 to £100,000£50,000 to £75,000£25,000 to £50,000£20,000 to £25,000£15,000 to £20,000£10,000 to £20,000£5,000 to £100,000£2,500 to £5,000£1,000 to £2,000Up to £1,000

0

5

10

15

20

Source: gov.uk

The measure has deterred pension saving among wealthier individuals who have looked elsewhere for tax-efficient options for their capital.

With a 30% tax credit on capital subscribed in a VCT share issue and all income and capital gains tax free, VCTs are the first port of call for many investors now. VCTs have been very big issuers of shares in recent years as a result.

The companies held in a VCT do not tend to pay dividends, unlike ‘regular’ equities, because they are early-stage growth companies. Instead, VCT managers pay dividends from realised profits when they sell stakes in successful holdings.

REVENUE RESERVES £M (LATEST ANNUAL REPORT)

UK

Global equity

Regional

£ million

£480

£500

£520

£540

£560

£580

£600

£620

£640

£660

Octopus Titan, which has grown dramatically in recent years on the back of repeated issuance of new shares and good investment performance, is the largest dividend payer of them all. It distributed a huge £135m in dividends in 2021, a record for the sector and more than a quarter of the total £492m paid out by VCTs last year.

Blackfinch Spring VCT, targets a dividend yield of 5% from 2024 which, of course, are variable and not guaranteed.

VCT dividends fell by 6.6% in 2020 owing to the chilling effects of the pandemic, but have more than made up for that since.

Moreover, they have more than tripled in the last ten years.

Private equity has some similarities to venture capital but the investment trusts do not attract the same tax breaks. It too has become a significant payer of dividends, worth £576m in 2021, the largest of any category of trust. 3i Group is dominant, accounting for two thirds of the dividends from the sector in 2021.

The dividend stream from private equity investment trusts is more volatile than from VCTs owing to the way the business model functions but also because investors in the latter prize the tax-free income very highly, whereas investors in the former tend to focus more on capital gains.

Source: Link Group

Beyond funds focused on listed equities, investors can choose from a broad range of other investment themes, covering private assets, debt, property (the largest dividend-paying alternative sector) and much more.

This diverse group was responsible for two thirds of the total dividends paid by investment trusts of any kind in the year to the end of March 2022, up from just two fifths a decade ago. In the twelve months to the end of March they distributed £3.65 billion between them, an increase of 25%.

The biggest increase came from Venture Capital Trusts (VCTs), up by £221m or two thirds. Property trusts and renewable infrastructure also made a significant contribution to growth.

VCTs have proved very popular with investors in recent years who have been attracted by the generous tax breaks that come with this category of fund. A reduction in the lifetime allowance on pension funds is catching more and more savers with punitive tax on their pension pots.

ALTERNATIVES - INVESTMENT TRUST DIVIDENDS £M

Source: Link Group

By tucking away a portion of the dividends they earn each year, in bad times VCTs can release this cash and shield their investors from cuts in the dividends they receive.