venture capital trusts
Industry Update - FEBRUARY 2022
1. INTRODUCTION
The latest news, updates and statistics on VCTs
2. Market Update
3. Considerations for Investment
4. Industry Analysis
5. Managers in Focus
6. What's on the Horizon
7. Further Learning
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Accredited by:
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Industry Update - december 2021
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Opening Statement Acknowledgements and Thanks Key Findings
1. Introduction
Market Composition Fees and Charges Performance Targets MICAP Market Snapshot
3. Considerations For Investment
2021 in VCTs: The Year of the Rebound Dividend Tax Hike in April—What to Expect? Role of VCTs in Portfolios VCTs - Time to Diversify
The VCT Market is Now a Good Place to Be - Nick Britton, AIC Will Financial Advice be Excluded from FSCS Coverage? The 10% Depreciation Rule Extends for a Year What the Managers Say Q&A with Octopus Investments
2. market update
Blackfinch Calculus Downing Octopus Puma VCT Solutions Comparison
5. managers in focus
High-return Investments and the FCA’s Quandary Rising Inflation and Higher Taxes—What Role for VCTs? What the Managers Say
6. what's on the horizon
Learning Objectives CPD and Feedback About Intelligent Partnership Disclaimer
7. further learning
2. MARKET UPDATE
3. CONSIDERATIONS FOR INVESTMENT
4. INDUSTRY ANALYSIS
5. MANAGERS IN FOCUS
6. WHAT'S ON THE HORIZON
7. FURTHER LEARNING
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Opening statement
Photography by Interview by
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ne reason I’ve often heard for not using VCTs is that “we don’t let the tax tail wag the investment dog”. Fair enough, but perhaps those who incline to that view haven’t taken a look at VCT performance recently. The average VCT delivered returns of 24% last year, helped by exposure to the kind of businesses that did well in the pandemic. More significantly, it was the thirteenth consecutive year of positive returns for the sector (and these figures include defunct VCTs, removing survivor bias). Remarkably, VCTs have not had a “down” year since the financial crisis. VCTs’ robustness during the pandemic was shown not just in total return terms, but by the continuing stream of tax-free dividends. Out of 57 dividend-paying VCTs, 29 have not cut their annual dividends at all since Covid struck. A further 12 have already returned to pre-pandemic payout levels. Yields now average 6.6% for Generalist VCTs and 5.8% for AIM VCTs, with many VCTs targeting yields of 5%, worth 7.4% and 8.1% for higher and additional rate taxpayers respectively. Looking through the investment company structure into VCTs’ portfolios is also cheering. A recent report from Wealth Club, which covers three-quarters of the VCT market, finds that nearly half (43%) of VCT investments are in companies that grew revenues more than 25% last year, while 31% have achieved year-on-year growth rates of more than 50%. If there is one note of caution, it is about valuations. VCT managers are seeing plenty of opportunities, but some of them are highly priced. We already know this year will be a record for fundraising –money that will need to be deployed within the next three years under the VCT rules. VCTs do have one advantage here, which stems from their fund structure. When a client invests in a “top-up offer” (the most common kind of offer), that client gets immediate access to a VCT’s existing portfolio. That existing portfolio will typically include companies that received investment from the VCT in different years, and are at different stages in their growth. Some may be ready for sale. As a result, a general climate of higher valuations may be as much an opportunity as a threat. In any case, the “diversification of maturities” within the VCT serves to steady the ship. In the early years of VCTs, it mattered quite a lot whether your VCT was launched in 1999 or 2001, or to use a more recent example, in 2007 versus 2009. With longer-established VCTs, which raise modest amounts each year, the “J-curve” has been considerably smoothed so it looks a bit more like the famous Nike swoosh. Of course, it’s important not to let complacency set in. Past returns are no guarantee, and average performance conceals a lot of variation. But to eke out 13 consecutive years of positive returns from an asset class that is intrinsically high-risk is quite something. It suggests that VCT managers are, on average, doing a good job of picking the right companies and working with them to achieve profitable exits. Their success should be celebrated – along with the hard graft of the entrepreneurs whose risk-taking makes it all possible.
O
- Name Surname
Remarkably, VCTs have not had a “down” year since the financial crisis.”
nick britton
Head of Intermediary Communications The Association of Investment Companies (AIC)
www.theaic.co.uk 020 7282 5555 enquiries@theaic.co.uk
This report and the research behind it would not have been possible without the help and support of a number of third parties who enthusiastically shared their time and expertise. These busy professionals went to great lengths to provide us with data, their insights on the market, and useful comments and suggestions while peer reviewing initial drafts. We thank Nick Britton, head of intermediary communications at the Association of Investment Companies (AIC), who once again generously provided the opening statement for this update. We are grateful for his unfailing support over the years. We’d also like to show our gratitude to Nic Pillow and Dr Reuben Wilcock of Blackfinch; Matthew Moynes of Calculus Capital; Tom Mullard, Nick Priest and Richard Lewis of Downing; and Rupert West and Lewis Kilminster of Puma Investments. The expertise of one and all have improved this study in innumerable ways and their support as sponsors has made this update possible. Any errors and omission are our own. We have relied upon MICAP for most of the data that we have based the update upon. MICAP is part of the same group of companies as Intelligent Partnership. We also carried out our own extensive desk research and interviews to verify their data. The update is made possible by our sponsors, who have contributed copy to the update and supported us by helping to meet production costs. So, a big thanks to Blackfinch, Calculus Capital, Downing, Octopus Investments, and Puma Investments.
Acknowledgements and thanks
learning objectives for cpd accreditation
Identify the main themes and trends in the VCT market Define the typical charges investors can expect with VCT Describe major legislations and their impact on VCT Evaluate VCT performance in 2021 Explain how potential tax changes might affect the appeal of VCTs Analyse the role of VCT in the era of rising inflation, interest rates, and taxes
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After you have reviewed this publication and before we fulfill your CPD certification request, we will be requesting your feedback on it. Your collaboration will assist us to enhance the learning activity, and will inform improvements to future publications.
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Key findings
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percentage of UK adults who have received financial advice, FCA
8%
proportion of investors investing for the first time in, or increasing their holdings of, high-risk investments during the pandemic, FCA
6%
Value of shares issued by VCTs in 2020/2021, 4% higher than 2019/20
£668m
April 2022 increase in dividend tax to help support the NHS and social care
FSCS levy for 2021/22, or 28% higher than 2020/21
£833m
The percentage of the 126 companies listed in the UK in 2021 that were tech companies
29%
share of adviser revenue derived from ongoing advice
76%
67%
£
percentage of consumers who believe they can make investment decisions themselves
%
This update has thrown up some interesting, sometimes alarming, sometimes revealing facts and figures. So we've selected a few to give you a flavour of the current context, some food for thought and some indicators of the fundamentals you should be aware of.
1.25%
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"The VCT Market is Now a Good Place to Be" - Nick Britton, AIC Financial Advice to be Excluded from FSCS Protection The 10% Depreciation Rule Extends for a Year What the Managers Say Octopus Q&A
“The VCT market is now a good place to be” - Nick Britton, AIC
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The average age of the current VCT investor is 56, down from 67 in 2017 - that’s an 11-year rejuvenation of a growing investor base that is making a real difference. Beyond their impressive financial performance, VCTs continue to deliver innovation and positive environmental and societal impact. In short, the future looks bright. During Intelligent Partnership's February 2022 VCT showcase event at the London Stock Exchange, Nick Britton ACSI, head of Intermediary Communications at The Association of Investment Companies (AIC), discussed the performance of venture capital trusts (VCTs) over the past 25-odd years. The sector is emerging stronger from a challenging pandemic to face the future with renewed confidence. VCTs are more mature, with experienced managers running well-established funds with strong track records.
- nick britton, aic
Performance, excluding tax reliefs, has to be the most important criterion against which VCTs are judged. So it’s reassuring to see that the last year of negative returns for the sector as a whole was 2008 – with the obvious caveat that this is just a sector average and there is a fair degree of dispersion.
Will financial advice be excluded from FSCS coverage?
The Financial Conduct Authority (FCA) has proposed excluding investment advice from the Financial Services Compensation Scheme (FSCS) protection.
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Currently, the FSCS may compensate you for bad regulated advice which caused you to lose money. (The advice must have been given to you on or after 28 August 1988). But the city watchdog is concerned about the mounting costs of the scheme. “The FSCS’s operating costs and compensation payments are funded by levies on financial services firms. Increasing compensation costs seen in recent years have prompted questions about the fairness of FSCS levies and how the FSCS should be funded,” the regulator wrote in its compensation framework review in December. The overall FSCS levy has increased over the last decade, from £277 million in 2011/12 to an expected £717 million for 2021/22. Many of the claims driving these costs relate to historic misconduct by firms in the investment sector, including financial advisers and Self-Invested Personal Pension (SIPP) operators, which have subsequently failed, says the regulator. This pipeline of historic claims is expected to result in further FSCS payouts over the coming years. The FCA has asked the industry for feedback on whether the scope of protection should be aligned with other jurisdictions. If implemented, the FCA’s proposal will reduce the scope of the FSCS. This would mean that consumers suffering financial losses as a result of the failure of an investment intermediary would not be protected by the compensation scheme.
The FSCS protection
The FSCS is the 'fund of last resort’ for customers of authorised financial services firms. It provides compensation-- up to a maximum of £85,000 per provider—when certain authorised financial services firms are unable, or likely to be unable, to meet claims against them. “If you have an investment (or you were advised to invest) and the provider or adviser has gone out of business, you may be able to claim compensation with FSCS,” the agency says on its website.
• If the firm failed after 1 Apr 2019 - up to £85,000 per eligible person, per firm. • If it failed between 1 Jan 2010 - 31 Mar 2019 - up to £50,000 per eligible person, per firm. • If it failed before 1 Jan 2010 - 100% of the first £30,000 and 90% of the next £20,000 up to £48,000 per eligible person, per firm.
FSCS compensation limits
The case of investment companies
Investment companies are not authorised firms and investors in investment companies are shareholders, not customers, notes the Association of Investment Companies (AIC). This means that investment company shareholders are in the same position as shareholders in any other listed company and exercise their rights collectively through the board of directors. Therefore, continues the AIC, “investment companies are not covered by the Financial Services Compensation Scheme (FSCS), as the FSCS is designed to provide compensation where an individual, who is a customer of an authorised firm, has a claim against that firm which it is unable to pay (e.g., due to going bust).” That said, however, if an individual investor were holding investment company shares through a platform or savings scheme, then the investor would be a customer of the platform or savings scheme provider, which would be an authorised firm, and so the FSCS would apply the operation of the platform or the savings scheme, says the AIC.
What potential impact on VCT funding?
Most VCTs get investors from three main sources: financial advisers, execution only platforms, and direct investment. Surveys have found, however, that a large majority of people investing in VCTs receive financial advice. A typical case is one manager who reported that 62% of its investors came through financial advisers. Direct investors and investors from execution-only platforms represented respectively 20% and 18% of its clients. Those inflows have stayed fairly consistent through the three channels. However, others have reported seeing an increasing flow from execution only platforms, perhaps driven by declining minimum investment levels. Presumably, non-advised investors, who typically invest smaller amounts, would be less likely to be concerned about (or even aware) whether or not FSCS coverage applies. At the other end of the scale, high net-worth and sophisticated investors, who provide a lion’s share of the funds, may not necessarily be advised. For both these groups, the proposed lifting of the FSCS protection may not impact significantly on their levels of investment. The investors most likely to be worried about a lack of FSCS coverage are those in the middle tiers of funding. Such investors might potentially cut down on their investment, or stop investing altogether, into VCTs and other venture capital schemes. How much impact, overall, such a pullback could have on VCT funding—if ever the proposal becomes law—remains to be seen. Meanwhile, the large inflow from financial advisers appears to be driven by VCTs becoming increasingly mainstream in the financial adviser community, as alternative options for tax efficient investing diminish. At the same time, the increasing flows from execution-only platforms result from growing confidence in the direct investment community to self-select their investments, combined with some fairly attractive fee discounts which are available via this channel.
Advice is going strong despite the headwind of turbulent market
The advice industry has faced uncertainty and volatility as a result of the pandemic and its associated lockdowns. Warning bells have been sounded over the future of some smaller businesses; deep concerns have been raised over the burden of regulation and a hardening professional indemnity insurance market. Until now, however, the industry has bucked the gloomiest predictions made for it over the past five years. Adviser defaults still represent a very small percentage of advice firms. In 2020/21, the FSCS says, only 92 authorised financial services firms failed (not all advisory firms) while the FCA regulates the conduct of around 51,000 businesses. Despite a wave of consolidations across the market in recent years, the overall number of advisers in the industry has remained stable.
- jessica franks, head of retail investment products, octopus investments
VCTs can be useful in tax planning where clients want exposure to early-stage investments.
record number of scam warnings issued by FCA in 2021
1,300
How to check your investments are FSCS protected
Source: FSCS
The 10% depreciation rule extends for a year
When the Covid-19 pandemic hit, the Financial Conduct Authority (FCA) announced a significant package of “reprioritisation” and “deprioritisation” of regulatory work. These modifications were designed to ease the regulatory burden on firms and allow them to concentrate their efforts on responding to the crisis and the consumers they serve.
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Amid the bundle of amendments, was a much-welcomed relaxation of the 10% depreciation rule, which came in with Mifid II in January 2018. Prior to this loosening of the rule, certain firms were required to inform their investors every time the value of their portfolio assets dropped by 10% or more during the relevant reporting period—by the end of the following business day. These included firms providing portfolio management services or holding retail client accounts that include leveraged investments. The easing of the rule, announced in a Dear CEO letter 31 March 2020, allowed managers to issue only one notification within a reporting period, provided they continued to give general market updates to their clients. Further, the firms were allowed to stop providing these depreciation reports for any professional clients. The regulatory relief comes in response to some unintended consequences. With the advent of the Covid-19 pandemic and during the ensuing volatility, some notified investors would react in panic and take precipitate action to sell their holdings. Such a move would have been ill-advised and detrimental to most investors during the temporary slump experienced at the beginning of the Covid-19 pandemic. The regulatory reprieve was initially for a period of 6 months, to 1 October 2020. Subsequently, the city watchdog said in a statement: “This period of flexibility has given us the opportunity to consider the effectiveness of the 10% depreciation notification requirement.” The regulator confirmed plans for consultation on permanent changes. “We intend to consult on changes to the requirement later this Spring. We are therefore extending the temporary measures for firms until the end of 2021 while we undertake policy work on the future of the requirement.”
The latest extension, in the final weeks of 2021, will extend the temporary measures for firms for a further 12 months (until 31 December 2022), “whilst HMT and/or FCA policy work on the requirement’s future is concluded”. During this period, the regulator pledges to take no action for breach of law on the condition that firms: • issued at least one notification in the current reporting period, indicating to retail clients that their portfolio or position has decreased in value by at least 10% • informed these clients that they may not receive similar notifications should their portfolio or position values further decrease by 10% in the current reporting period • referred these clients to non-personalised communications, perhaps made available on public channels, that outline general updates on market conditions (these could contextualise potential drops in portfolio or position value to help consumers meet their objectives, rather than making impulse decisions about their investments) and • reminded clients how to check their portfolio value, and how to get in touch with the firm The government's policy work on the requirement’s future remains ongoing.
One more year of relief
the length of the temporary extension of the 10% rule (until 31 December 2022)
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- Rupert West, Investment Director, Puma Investments
VCT investment has grown significantly in recent years with more investors recognising the opportunities that VCTs present to gain exposure to attractive, fast-growing companies whilst benefiting from tax breaks that address their financial planning needs. I expect their popularity will only accelerate over the coming years
months
What the managers say
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We seem to be heading into an era of high inflation and rising rates—how do you see VCTs faring in this investment climate?
In general, what is the place (if any) of high-risk/high-return investments in this era?
With interest rates still very low by historic standards, we expect greater demand from investors for high-growth, inflation-beating investments. Of course, higher risk investments should form part of a balanced portfolio. Many VCTs have low minimum investment amounts and are therefore ideal for investors seeking a small, but meaningful, exposure to high-growth start-ups.
nic pillow
Ventures Manager Blackfinch
So how are the managers feeling about the VCT market and overall investment market conditions? Here's what they have to say.
The UK aims to be the world’s first net zero financial centre (the Chancellor says), and the FCA has taken up the challenge. How can VCTs also prepare themselves for the challenge?
VCTs make long-term investments into companies that will help shape the future economy. As an ESG-focused investor, we believe it’s essential that every new investment made by a VCT is environmentally sustainable. The good news is that there are thousands of innovative start-ups ready to lead the charge in delivering the clean economy we desperately need.
There are many conflicting opinions and theories when it comes to the impact of inflation on overall stock market returns and it is a reminder that we should never talk in ‘absolutes’ when discussing economic theories. Add to this a collective tendency to overcomplicate and overanalyse and its easy to see why its often hard to cut through the market noise. But let’s strip it back, inflation is simply the rising costs of goods and services which erode spending power. As a result, investors need a source of portfolio income that can outpace inflation. Fixed rate bond interest payments fall at this hurdle, but dividend distributions can provide a welcomed solution. The tax-free dividend yields targeted by VCTs provides an alternative source of reliable portfolio income, driven by the performance and valuation growth of unquoted companies often shielded and isolated from the market trends seen across listed equity. At a time when investors may be looking to rebalance their portfolio due to macroeconomic headwinds and uncertainty, a VCT’s long term investment view combined with consistent dividend payments and tax breaks, should align them as a popular choice during the rebalancing process.
Irrelevant of rising inflation and interest rates, the potential upside through capital growth accessible through these smaller, unquoted, risk to capital assets completely eclipses that of their publicly listed counterparts. Investors willing to soak up additional risk may gain exposure to a growth trajectory not seen amongst traditional asset classes. From a holistic portfolio perspective, venture capital offers further diversification from the cyclical and defensive securities held across equity indices and long only funds often found across most discretionary managed portfolios.
The relationship between a VCT manager and its underlying portfolio companies often goes well beyond just provision of capital. Managers typically work very closely with each investee company offering guidance throughout their growth journey. This level of proximity means the Manager can also support the portfolio companies as they adopt practices, policies and processes which build a net zero commercial model and support the UKs future roles as a global hub of green finance.
matthew moynes
Assistant Director Investor Relations Calculus
With VCTs only focusing on high growth companies since the introduction of the risk-to-capital test, they will still offer genuinely higher returns to investors even with higher inflation levels and interest rates. VCTs that consistently pay dividends are always attractive to investors as the tax-free nature of the dividends enhances the returns to investors compared to normal shares, but this becomes even more important when real returns are eroded by inflation. From an investment point of view, we do not think that the quantity and quality of investment opportunities will be adversely affected during an inflationary period.
It’s worth noting that most high-risk/high return investments such as VCTs are long-term investments, with hold periods of at least 5 years, arguably longer with most VCTs now being evergreen. Whilst the absolute returns may not be as strong during a period of high inflation, the returns over the lifetime of the investment would still be expected to be strong, once this current period of high inflation and rising rates has passed. You might see a shift in a portfolio towards commodities or maybe real estate in a period such as this, but we would expect high-risk/high-return investments to still be a part of that portfolio.
Smaller companies have a natural advantage over larger companies when it comes to their emissions. Whilst changing the physical footprint and energy needs of a company can be disruptive, choosing to adopt an energy efficient footprint as a company grows, is much simpler. That’s why we think that VCT managers can embed a net-zero commitment in their term-sheet; access to investment is a powerful motivator for portfolio companies if the impending climate crisis isn’t already enough. We also recognize the effect that TCFD adoption will have on the industry; even if smaller companies currently fall below the scope of the mandatory requirement, they would do well to think about the four components as they grow.
Tom Mullard
Director, Product Development & Strategy Downing
VCTs are an important vehicle for providing a source of patient capital to smaller companies. Smaller companies can be more resilient than larger companies during turbulent economic times as they are able to pivot more easily. Private companies are also less likely to be impacted by market sentiment as they aren’t listed on the stock exchange.
Increases in inflation alongside rising interest rates might drive investors to seek growth through alternative forms of investment, providing they’re comfortable with the risk. Changes in tax treatment such as the lifetime allowance freeze might also encourage those looking for higher returns to take on additional risk as part of a diversified portfolio.
VCTs invest into smaller early-stage companies that are typically well placed to adapt and even evolve industry best practice. Many of our portfolio companies operate in sectors with a specific focus on building a sustainable planet. Across all products, our investment and assessment process includes ESG considerations and a policy of stewardship to support businesses to reach their sustainability goals.
jessica franks
Head of Retail Investment Products Octopus Investments
Newer VCTs, like ours, have portfolios focused on young, innovative companies with high growth potential. These companies grow because they satisfy a clear market need, often disrupting more established businesses. Rising prices will only encourage customers to hunt around for these newer solutions, helping drive more rapid growth in the start-ups – and ultimately higher returns for investors.
VCT portfolios will react in different ways to rising rates. VCTs with large portfolios of highly priced tech businesses will struggle in a rising interest rate environment, as the value of potential future earnings are marked down. Look for VCTs with a wider sector spread to give more cushion.
In this or any other era, the thing to focus on is whether your high risk is balanced by the potential for high return. Seek out VCTs that are small enough for each position to deliver meaningful returns if it does well. Otherwise, you’re taking capital risk (from backing small companies) for income-like return.
VCTs have the chance for a front row seat in the net zero revolution by backing the technologies that will take us there. Alongside that, VCT managers have a responsibility to guide portfolio companies though an ESG journey; this does good in its own right but is also an increasingly essential aspect of getting portfolio companies exit ready.
rupert west
Managing Director Puma Private Equity
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Why have you launched the Octopus Future Generations VCT? Over the last 18 months we have been having numerous conversations with our customers and their advisers about what they want from their investments. Investors are increasingly conscious of where their money is invested and the type of companies they’re investing in. In recent years there has been a growing demand for investment products to not just generate returns for investors but to also provide a societal benefit through the investments they make. We think venture-stage companies can be particularly powerful in meeting both of these investor objectives. The companies we’re going to invest in through the Future Generations VCT are seeking to solve some of society’s biggest challenges. In doing so these companies are bringing new and innovative technologies to the markets they operate in, and we know that disruptive companies offer fantastic growth potential. Why do you consider this an exciting development for investors, start-ups and the British economy? I think it’s exciting for investors because it gives them extra choice; it gives them a way of focusing their money on things that they specifically care about. Critically, from an adviser’s perspective, it allows them to offer their clients access to innovative products with the comfort that the investment is being managed by a venture investment team with a very long and successful track record of investing in growth-stage companies. So you’ve got loads of experience working for you. It is also great news for smaller companies, which are critical for UK economic growth. It is particularly exciting for companies that operate in areas that this VCT focuses on, building a sustainable planet, empowering people, or revitalising healthcare. This VCT will give a valuable source of capital to companies set to deliver lasting change in these areas. How does this VCT fit in with Octopus’ B Corp status and wider approach to responsible investing? We became a Certified B Corporation (B Corp.) a couple of years ago. We see B Corp. as a reflection of how we behave as a company - that we care as much about community, our planet and customers - as we do about our shareholders. Launching products with sustainability themes gives investors the opportunity to align with those values if they feel as passionately as we do. The Octopus Future Generations VCT expands upon our existing sustainability offering, following the launch of the UK Future Generations Fund in September 2021. The UK Future Generations Fund invests in listed companies focused on the same three sustainable investment themes. What kind of companies will fit the three sustainable themes? Can you give examples of existing Octopus portfolio companies? Going through the three themes briefly: Building a sustainable planet—this is about investing in companies that aim to reduce carbon emissions, protect a range of ecosystems, or create a circular economy that removes waste. An example of a company we’re already invested into through our other VCT products is a company called Olio. Olio is a food sharing app that allows extra food to be shared between neighbours and avoid food waste. To date, five million people have joined the OLIO community and they’ve shared 40 million portions of food, and counting. Empowering people is about building a better society. A good example is a company called WeFarm, which is the world’s largest digital network that specialises in connecting small-holder farmers to one another. This helps them to pool their knowledge and resources to increase yields, gain insight into pricing, tackle the effects of climate change and diversify their agricultural interests. I lived in West Africa for a while, and I know that one of the biggest challenges that farmers had there wasn’t growing crops; it was knowing how much their crop was worth at market. WeFarm, as the world’s largest farmer-to-farmer digital network is well positioned to address these crucial issues. Revitalising healthcare—how do we back growth-stage companies that try to solve healthcare problems in an innovative way. Another of the companies Octopus is already invested in is called Quit Genius. It’s a digital clinic that delivers a comprehensive treatment programme for multiple addictions. It’s 100% digital, and they have a smoking quit rate of 53%, which is astonishing. Why is it important to drive money towards these kinds of businesses? There are a few reasons. Firstly, because we think some of the best returns over the next few decades could come from businesses solving the world’s biggest problems. But also because smaller companies are the lifeblood of the UK economy. We know they create disproportionate numbers of jobs and are very likely to innovate and disrupt the industry they operate in. Given their growth potential these companies are really important for UK PLC. What is your ultimate vision for the Octopus Future Generations VCT? I’d like to see us create as many opportunities for UK growth companies to gain access to funding as possible, so we’d love if it one day grew to be as big as Octopus Titan VCT, the largest VCT in the UK.
Introduction
Market Update
Considerations for Investment
Industry Analysis
Managers in Focus
What's on the Horizon
Further Learning
Ruth Handcock
CEO octopus investments
Q&A with RUTH HANDCOCK
Octopus Future Generations VCT: “Solving the world’s biggest problems”
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www.octopusinvestments.com +44 800 316 2295 support@octopusinvestments.com
Opening Statement Q&A with Richard Stone, AIC Update Overview Key Findings
Market Composition Targets
What Advisers learned from the Woodford Debacle Thriving on Disruptive Innovation VCTs and the New Era of Retirement Planning
The Golden Age of Fundraising What is bringing Investors to VCTs The No-news Autumn Budget The Two Sides of the Great Fee Debate How to Use VCTs for Retirement Why Investments in Smaller Companies can be a Valuable Addition to a Client’s Portfolio What the Managers Say
Blackfinch Calculus Downing Octopus Puma Comparison Table
Post-Covid: the New Normal The FCA &The ESG Renaissance Younger Investors are Discovering VCTs What the Managers Say
Learning Objectives CPD and Feedback About Intelligent Partnership Disclamer
Building a sustainable planet—this is about investing in companies that aim to reduce carbon emissions, protect a range of ecosystems, or create a circular economy that removes waste.
Empowering people is about building a better society.
Revitalising healthcare—how do we back growth-stage companies that try to solve healthcare problems in an innovative way.
Market composition
In this section we will take a look at market trends, some statistical breakdowns, open offers as well as the fees and charges you can expect to see from VCT offers. Unless otherwise stated, the analysis is based on data obtained from MICAP and is correct as of 3 February 2022.
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As in recent years, 100% of open offers are concentrating on a growth-and-income strategy, a trend that has come to be expected. These VCTs aim to provide long-term capital growth and/or a steady stream of dividends. Another continuing trend is the concentration on the general enterprise sector, which continues to capture the lion’s share of the open offers (89.7%). These VCTs invest in a wide range of small, usually unquoted companies in a wide variety of sectors – from retail to healthcare and technology. The idea is to diminish risk by diversifying, so if one sector suffers setbacks, another might shine.
VCT investee companies
percentage of total VCT investments claimed through self-assessment
89%
66.7%
11.1%
22.2%
A unicorn is a private company valued at $1 billion (£718 million) or more. Worldwide, the growth in the number of unicorns has paralleled the global funding increase for new ventures and tech startups. The term unicorn was introduced by venture capital investor, Aileen Lee, in 2013. The moniker was meant to reflect the particular attributes of a unicorn: something highly desirable, but very difficult to obtain.
Open offers
Nearly seven per cent (6.9%) of open offers focus on technology, capitalising on the explosion of interest in that sector. Technology companies raised a record £6.6 billion from initial public offerings (IPOs) in 2021, more than double the £3.1 billion raised in 2020, according to figures from the London Stock Exchange (LSE). A total of 126 companies listed in the UK in 2021, raising a total of £16.9 billion. Of these, 37 (or 29%) were tech companies, including fintech Wise, consumer review site Trustpilot, online marketplace Auction Technology Group, and ride-hailing app Deliveroo—several of them benefiting from VCT funding. More funding means more unicorns, with 29 created in 2021. This takes the UK’s total unicorn figure to 116, meaning 25% of the UK’s total unicorns were created in 2021 alone. The UK has more unicorns than France (31) and Germany (56) combined. In December 2021, a press release by the Department for Business, Energy & Industrial Strategy proclaimed that the UK tech sector had achieved the ‘best year ever’. Looking ahead, the next few years promise more success for the tech sector. In the last budget, the Chancellor announced a record increase in public investment in research and development (R&D) – committing to reaching £22 billion per year by 2024 to 2025.
VCTs, tech sector, and ‘best year ever’
The pharmaceutical sector is the focus of 3.4% of open VCT offers. During the global pandemic, the pharmaceutical industry has worked hard by researching, developing and producing diagnostics, treatments and vaccines. This effort has resulted in the unprecedented discovery and production of effective vaccines against the virus, thus lowering the risk of infection and hospitalisation. Pharmaceutical companies have the potential for amazing growth, even though they are saddled with expensive research, testing and regulation. Once a drug is patented, it is protected for 20 years during which competitors cannot make their own generic versions. During the pandemic, the focus has been primarily on pharma giants, companies having high levels of research and development capabilities. The rest of the pharmaceutical and biotechnology sector has been facing some extent of volatility. It’s worth noting, however, that in pharmaceuticals as in other sectors, the ingenuity and nimbleness of some SMEs has allowed them to take advantage of the opportunities presented by Covid, particularly when they are in receipt of the funding and business support that VCTs can offer.
Pharma: developing potential vaccines and treatments for Covid-19
open offers by investment sector
General Enterprise
89.7%
3.4%
6.9%
Technology
Pharmaceuticals & Biotechnology
Looking at the type of investee companies, we see that 63.6% open offers invest in early-stage companies, compared to 18.2% in each of AIM-listed and later-stage companies. As shown in the following section (See Target investee companies in the Performance and targets section), the average open offer aims to invest in over 50 companies in a variety of industries. This broad assortment of investee companies provides tremendous diversification. Because of this, a VCT can provide a safety net by strengthening an overall investment portfolio. By offering investors access to an instantly diversified portfolio of smaller companies, VCTs can offer an attractive way to gain exposure to the fastest growing sectors of the UK economy. In short, you can invest in a VCT without worrying about the hassle of sorting research, diversification, complex reporting and too much paperwork.
Investee companies: diversification
open offers by investee company type
18.2%
63.6%
Early stage
Later stage
AIM listed
- jessica franks, head of investment products, octopus investments
For the right client, VCTs can be a great first step into venture investing.
Fees and charges
In our previous VCT Update in December 2021 we reported a downtrend in most VCT fees. This downward movement seems to have accelerated.
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At the time, we noted that all fees had declined, except the Annual Management Charge (AMC) to investors and the initial charge to investors. Since then, all fees have continued to fall with the exception of the AMC charged to investors, which has increased by 1.5%. Particularly noteworthy is the AMC charged to investee companies which has tumbled by more than half (-50.7%). Such a precipitous drop raises the question as to why. It could be that there has been a shift in the balance of power in the market. Do investee companies have more bargaining power in the current market? Perhaps the best prospects appreciate their own value at a time when the market has an abundance of suitors.
The VCT fundraising season got into full swing in September and was a time of several rounds of impressive fundraising. During the pandemic and at a time when the UK’s young companies have needed it most, the VCT sector has raised £685 million for investment in small, innovative UK businesses. Where reported, open VCT offers target an average £1,000,000 in fundraising, less than the historical average minimum fundraise of £2,400,000. Whatever the reason, lower fundraising targets bring in more investors. That is what happened last year, when a 7.5% drop from the previous year allowed the most popular offers to be filled well in advance of the end of the tax year. Overall, 13 of the year’s 22 offers (comprising 20 of the 30 individual VCTs raising funds) were fully subscribed before 5 April 2021. Much of the investment went to support healthcare, science and technology businesses which have helped in the battle against coronavirus, said the AIC. “It demonstrates that demand for VCTs and the benefits they bring investors remains high at an extremely difficult time,” said former AIC boss Ian Sayers.
vct charges (february 2022)
Initial Charge to Investor Excluding Adviser Fee Initial Charge to Investee Company Total Initial Charge AMC Charged to Investor AMC Charged to Investee Company Total AMC Annual Performance Fee exit performance fee annual performance hurdle exit performance hurdle initial deal fee exit deal fee annual admin charge
2.66 1.0 3.23 2.00 0.37 2.13 15.04 0.66 5.22 0 0 0 0.06
2.5 0 2.5 2 0 2 20 0 0 0 0 0 0
2.5 0 2.5 0 0 0 0 0 0 0 0 0 0
3 5 7.5 2.5 2.5 4.5 20 20 120 0 0 0 0.35
Avg
mode
medium
maximum
vct average charges comparison
Initial Charge to Investor Excluding Adviser Fee Initial Charge to Investee Company Total Initial Charge AMC Charged to Investor AMC Charged to Investee Company Total AMC Annual Performance Fee Annual Administrative Charge Annual Performance Hurdle
2.92 1.25 3.75 1.97 0.75 2.39 16.39 0.09 8.06
nov 2021
2.66 1.0 3.23 2.00 0.37 2.13 15.04 0.06 5.22
feb 2022
-8.9% -20% -13.9% +1.5% -50.7% -10.9% -8.2% -33.3% -35.2%
change
minimum
The total initial charge has dropped by almost fourteen per cent (-13.9%); the total AMC is now almost eleven per cent less (-10.9%); both the initial charge to investors, excluding adviser fee and the annual performance fee have fallen by more than eight percent (-8.9% and -8.2% respectively). Almost every fund, even index-trackers, charges some kind of fee (fund providers are businesses, after all, and fees are their revenue model). From an investor’s perspective, however, fees are one of the most important factors when it comes to a portfolio’s long-term returns. Lower fees are good news for VCTs. Many believe that lower fees to investee companies will be passed on to investors. This is because lower fees mean fewer costs in investee companies and therefore lower performance hurdle needed for them to break into profit and generate dividends and overall growth. Therefore, the combination of low fees and tax efficiency is likely to boost VCT long-term gains.
- Tom Mullard, Director – Product Development & Strategy, Downing
AIM VCTs have never been more popular with record sums raised in a record time. Strong historic returns combine with greater levels of information available for listed portfolio companies than for unquoted companies to provide an attractive proposition for investors.
Performance targets
The year 2021 was a good one for Venture Capital Trusts (VCTs) in which they delivered an average total return of 24% in the midst of a pandemic that continued to play mischief across the economy.
If it can be argued that 2021 benefited from a bounce-back from the initial Covid-induced slump, it’s worth remembering that VCTs still managed to scratch out a positive 4% return during the arduous 2020. And if there was ever any question, the sector’s performance during the crippling pandemic has established VCTs and their bevy of hardy entrepreneurial businesses as a stalwart battalion in the difficult struggle against economic crises. 2022 promises to be another year of resilience and performance for VCTs. The sector continues to be on the right side of the lingering pandemic, with investment largely in sectors that are prospering during the crisis.
Target dividends
2021 marked the return of dividends after a period of suspension and reductions. Some of the UK’s biggest corporations resumed dividend payments, helping to support optimism around faster economic growth. VCTs are dividend payers and dividend reinventors. One of the advantages of VCTs for income-seeking investors is that they have the potential to pay out their profits to investors in the form of tax-free dividends. Dividends cannot be guaranteed, but open VCTs currently target an average of 4.84%. Some VCTs can also pay special dividends if there are significant gains from the sale of portfolio holdings.
target return of open offers
Target dividends for open offers
Target fundraising
minimum subscription of open offers
average
median
4.84%
5.00%
3.00%
7.00%
£2,900
£3,000
£1,000
£6,000
funds raised by vcts (£ millions), 1995-21
minimum fundraise of open offers
The amount of investment raised by VCTs has continued to increase year on year. While the number of VCTs raising funds decreased by 3 in 2020 to 2021 (40), the amount of funds raised increased to £668 million in 2020 to 2021, which is 4% higher than in 2019 to 2020 (£645 million)—according to data from HMRC. Looking over the recent years, we can see a rising trend, with the amount of funds raised more than doubling since 2009 to 2010.
Open offers aim to invest in an average of 51 companies. There’s an outlier that intends to invest in 108 companies. Even for VCTs that focus on one sector (e.g., technology or pharmaceutical), this abundance of holdings means a great deal of diversity in terms of sub-sector, geographic location, and company type, and other variables. Any single variable, say, sub-sector in technology, allows for investment in a multitude of areas. In this case, options include wired communication, wireless communication, computer programming, other IT, manufacturing, to name just a few. A VCT focusing on pharmaceuticals has the option of investing in biotechnology, drug manufacturing, animal health, and several other areas. For those VCTs that are ‘general enterprise’-oriented, the sky is virtually the limit in terms of where to look for growth and returns, although, of course, VCT qualification restrictions do apply to the age, size and public listing status of investees.
Target investee companies
51
70
0
49
108
Money has been flooding into VCTs ahead of the dividend tax rise expected in April. Dividend tax rates are set to rise by 1.25% at the start of the next tax year. Indeed, most taxes in the UK seem to be moving in only one direction currently. Because of the substantial tax breaks they offer, VCTs tend to benefit from this restrictive fiscal trend as more investors—and not just higher and additional-rate taxpayers—increasingly see them as an opportune investment option in these times. The combination of this growing appeal to tax-savvy investors, the greater restrictions on pension allowances, and the fact that VCTs tend to invest in fast-growing companies that have fared well during the pandemic positions the sector for a promising future. The average minimum fundraise of £1,500,00 is now 50% higher than the £1,000,000 we recorded in our November analysis. In the interval, the maximum fundraise has doubled from £1,000,000 in November to £2,000,000 today.
Source: www.gov.uk
target number of investee companies
£1,500,000
£1,000,000
£2,000,000
VCTs and the UK retail investment boom
There’s currently a surge in retail investment in the UK, according to research by Barclays Bank. “New research from Barclays Smart Investor reveals that the recent boom in retail investing is here to stay – with UK investors planning to increase their monthly investments by 19%, despite the easing of restrictions.” A recent poll by the London-based bank of over 2,000 UK investors revealed that three quarters (76%) of respondents are planning to continue their lockdown investing habits, with only 4% of first-time pandemic investors giving up once the world reopens completely. Minimum subscription for VCTs, a potential barrier to entry, has been coming down over the years. Today VCTs remain one of a handful of options available to small investors for exposure to high-return assets. The average minimum subscription for open offers currently stands at £2,900, having dropped by more than a quarter (26.47%) from the £3,944 we saw in November. There’s little doubt that retail investors continue to want access to the returns generated from investing in a portfolio of high-growth, earlier-stage privately owned companies. With VCTs now within reach of the average investor, one can only expect the sector to benefit from this fund inflow boom. Moreover, the VCT investor base is growing, attracting more female and young investors. Latest research by the Venture Capital Trust Association shows the average age of the current VCT investor is 56, down from 67 in 2017. This means that the typical VCT investor is now 11 years younger than just 4 years ago.
15
800
£ million
600
400
200
1995-96
2001-02
2005-06
2010-11
2015-16
2020-21
- Tom Mullard, Director, downing – Product Development & Strategy
With record levels of fundraising in the VCT market this year, we expect competition for deals to be intense over the next 12-18 months, and VCTs hat offer value-add to their propositions rather than just cash, can be expected to benefit.
MICAP Market Snapshot
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Leveraging its market overview position, MICAP is able to offer IFAs exclusive insight into the wider VCT market. As a sister company of MICAP, we are able to offer the following snapshot of data, which is updated in real time, and pulled from the MICAP website.
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2021 in VCTs: the year of the rebound
Throughout the Covid-19 pandemic, the Venture Capital Trust (VCT) sector has shown a remarkable capacity to spring back, rebound and successfully adapt in the face of adversity.
18
The virus reached the UK in late January 2020, and soon companies focused inwards and put fundraising on hold, waiting to see which way the unexpected wind blows. Towards the end of that year, however, the sector rebounded quickly. By autumn, businesses had begun to get a grip on the situation, adjusting their plans, and were starting to demand more capital. At the same time, investors had also begun to find their bearings; and by the end of the fourth quarter 2020, investment rates had outstripped those of 2019 and continued to rise in 2021. Based on figures just released by HMRC, a number of trends were in evidence for the VCT market in 2021.
2000-01
140
120
100
80
60
40
20
Number of VCTs raising and managing funds
Over the past several years, VCTs have been merging to achieve economies of scale. This trend continued in 2021 as the number of VCTs raising funds decreased, reflecting further concentration of the sector. The number of VCTs managing funds decreased in 2020 to 2021 as a few VCTs ceased to be active. Since 2010 to 2011, the number of VCTs managing funds has generally been decreasing, dropping to 57 in 2020 to 2021. To tally the number of VCTs managing funds, HMRC counts both VCTs which raised funds in the tax year and those VCTs which managed funds raised in previous years.
2. Fundraising is on the increase
While the number of companies operating as VCTs decreased in the tax year 2020 to 2021, the amount of investment raised by the remaining VCTs increased year on year. VCTs raised £668 million in 2020 to 2021, which was 4% higher than in 2019 to 2020 (£645 million). This increase in funding is also a continuing trend. The amount of funds raised by VCTs has been on a rising trend for several years and has more than doubled since 2009 to 2010.
VCTs are filling faster than ever and the expected record year of fundraising reflects this growing appetite. For investors and fund managers alike, there are an attractive range of opportunities.
1. Consolidation trend continues
Amount of funds raised by VCTs
“Several rules which were introduced during the period, namely the restricted enhanced share buybacks from April 2014 and the government’s Patient Capital Review consultation in summer 2017, may partly explain the increased fund raising between tax year 2014 to 2015 and tax year 2017 to 2018, as VCTs anticipated possible changes to the rules of the scheme,” noted HMRC. The increase in the Income Tax relief rate to 40% saw peak funds raised in 2005 to 2006 from the previous year. As well as anticipation of changes from the Patient Capital Review, HMRC said, the increase in funds raised during tax year 2017 to 2018 and tax year 2018 to 2019 is likely due to the reduction of the lifetime allowance from £1.25 million to £1 million. Interestingly, this is the first evidence from HMRC suggesting that speculations about an increase in VCT funding—in light of the freezing of the lifetime pensions allowance—are well founded. This increase in funding could well continue for the next four years. “This made traditional pensions less attractive. [There was also] the introduction of pension freedoms which allow for cash to be taken out of the pot for investment rather than buying an annuity, meaning there is more freedom for investment in alternatives such as VCTs.” HMRC sees the slight decrease in funds raised in 2019 to 2020 as a likely reaction to the VCT reforms introduced in 2017—which came into effect during later accounting periods—and potentially due to the impacts of Covid-19 towards the end of the tax year.
3. Income tax relief claimed
The amount of VCT investment on which income tax relief was claimed decreased by 16% in 2019 to 2020, compared to the previous year. The number of investors claiming income tax relief decreased by 11% to 17,725 in 2019 to 2020. However, HMRC advises caution about this data, noting that “[it] only covers claims made through self-assessment and will not cover investors making Income Tax relief claims through other systems (for example PAYE) or not making any claims.”
proportion of investors claiming VCT relief
As can be seen from the graph above, the amount of relief claimed and total funds raised by VCTs are largely consistent year on year. In 2019 to 2020, around 89% of the total VCT investments were claimed through self-assessment. The remaining amounts are assumed to be either claimed outside self-assessment or not claimed at all. This drop in the amounts claimed as tax relief merely reflects a drop in funds raised by VCTs in that tax year.
amount of investment on which relief was claimed
This correlation suggests that the amounts claimed in the current tax year, 2020/21, will rise to match the current surge in funds raised.
VCTs raising funds
VCTs managing funds
2004-05
2007-08
2013-14
2016-17
2019-20
Relief claimed
Funds raised
£150,000 to £200,000
£100,000 to £15,000
£75,000 to £100,000
£50,000 to £75,000
£20,000 to £25,000
£25,000 to £50,000
£15,000 to £20,000
£10,000 to £15,000
£2,500 to £5,000
£5,000 to £10,000
Up to £1,000
£1,000 to £2,500
5
% of investors
2018-19
Investment band
• VCTs issued shares to the value of £668 million in 2020 to 2021, which is 4% higher in comparison to 2019 to 2020 (£645 million) • The number of VCTs raising funds has decreased by 3 in 2020 to 2021 (40) • The number of VCTs managing funds has decreased by 4 in 2020 to 2021 (57) • In 2019 to 2020, VCT investors claimed Income Tax relief on £575 million of investment (a decrease of 16% from 2018 to 2019) • The number of VCT investors who claimed Income Tax relief decreased by 11% to 17,725 in 2019 to 2020
VCTs in 2021
Source: HMRC
Dividend tax hike in April—what to expect?
It’s happening on 6 April 2022: the rate of dividend tax will increase by 1.25 percentage points. This essentially means that investors will have to pay more on the money they get from owning company shares.
19
The tax rise will bite investors who have exceeded their dividend tax allowance; also feeling the sting will be owners of small companies who draw regular dividends which make up a significant part of their income. There is a tax-free dividend allowance of £2,000 in the 2021-22 tax year. Above that threshold, you pay tax based on the rate you pay on your other income (i.e., your tax band). The following table shows the dividend tax rates in the current and next tax years, based on your income tax band.
Source: brewin.com
2021/22
2022/23
7.5% 32.5% 38.1%
8.75% 33.75% 39.35%
basic rate
higher rate
additional rate
dividend tax rates
Income tax band
Pain points of a tax squeeze
Investing in dividend stocks can be a great way to build wealth over time, and it’s a strategy that has long been a favourite of British investors. This popularity implies that the tax hike could cause considerable pain. For starters, higher dividend taxes do have an impact on corporate behaviour. Research conducted in Switzerland determined that, in the presence of dividend taxes, companies tended to retain too large a fraction of their resources within the company instead of redistributing them to their shareholders. Subsequently, “companies massively increased their dividends following the abolition of taxation,” the study found. If the same correlation holds in the UK economy, it could lead companies to slash their payments to shareholders. On the other hand, one doesn’t expect VCTs—which are exempt from dividend tax—to lower their dividend payouts as a result of the tax increase. For investors, the dividend tax hike could come at a better time. The economy is currently struggling amid the twin scourge of inflation and rising interest rates. Prices of goods and services are rising while homes and savings are losing their value. Borrowing costs are going up for both firms and consumers. Meanwhile, businesses find it difficult to invest in a high inflation environment, where relative prices are variable. Struggling with supply chain shortages and rising input costs, many anticipate a reduced bottom line. This generalised anxiety is particularly pronounced for retirees, uneasy about inflation adjustments to their pensions and financial investments. To plan for retirement requires forming expectations of prices in the future. Inflation makes this more difficult because even a series of small, unanticipated increases in the general price level can significantly erode the real value of savings over time. And now, not only are investors looking at reduced dividend payments in general, but it is likely that many companies may forgo dividend payments altogether. More than ever, smart investors seek ways to avoid paying more tax than necessary.
A safe haven from dividend tax
High inflation and high interest rates provide the perfect opportunity to scrutinise and optimise your investment practice. Where can you diversify your portfolio and give it a booster at a time like this? VCTs could provide some answers. You will not have to pay a dividend tax if your money is invested in a VCT. In fact, dividend tax is so irrelevant to VCTs that you don’t even have to declare your dividend income on your tax return. The changes to dividend tax will bring investors looking for income, as the VCT remains an excellent source of additional income. Wealthier savers could also flock to VCTs as a means of reducing their tax bills and sheltering dividend income from the taxman. In addition to tax-free dividends, investments held into a VCT also provide up to 30% income tax relief and no capital gains tax, making it a highly tax-efficient way of saving and investing. On top of that, many VCTs have automatic reinvestment schemes which allow you to use the dividend to buy more shares in the trust. The amount reinvested typically qualifies for the 30% upfront income tax relief as a fresh VCT subscription. This is because, in most cases, the shares are newly issued rather than bought on the secondary market. While dividends cannot be guaranteed, many VCTs have a fairly reliable dividend payment history. Because of this, a diverse, well-established VCT portfolio can produce a satisfying stream of dividends throughout the year.
A structural advantage
VCTs can work very effectively in an inflationary environment. To a large extent this is a reflection of their closed-ended structure and the type of assets particularly favoured by this structure. “Because they issue a fixed number of shares on the stock exchange, investment company managers don’t have to buy or sell assets in response to changes in investor demand, as open-ended fund managers do,” notes the Association of Investment Companies (AIC). “Instead, investor demand plays out through changes in the share price and the discount to net asset value.” The closed-ended structure of VCTs means that managers don’t have to reserve a chunk of cash specifically to cover redemptions. Therefore, they minimise the ‘drag’ from low-return cash, a phenomenon that is exacerbated by inflation. Over the longer term, the combination of capital growth and dividend payments tends to offset inflation. In short, VCTs can give investors who are reliant on dividend income a chance to ride out the economic volatility that is widely predicted for 2022.
Certain animal species have evolved an adaptation that allows them to weather long stretches of time when food is scarce — they enter a state known as hibernation. Investment companies like VCTs have a special ability that is not entirely different. VCTs have an income advantage which is particularly important during difficult times like these when dividends are under pressure. Unlike open-ended funds, they don’t have to pay out all the income they receive from their portfolios each year. They can save up to 15% and tuck it into a revenue reserve. This means they can hold back some of the income they receive in good years and use it to boost dividends when businesses may be cutting theirs. “This structural benefit has enabled many investment companies to pay consistently rising dividends through both good and bad years for decades, a record that’s unrivalled by open-ended funds,” according to the AIC. For income seekers, this uncommon ability of VCTs to hold some revenue reserves of annual dividends received and use them to grow or maintain payouts in less prosperous years is a great blessing.
Thriving through thick and thin
number of savers that will be hit by the dividend tax increase by an average of £355 a year
2.5
- Oliver Warren, Investor Relations Associate, Calculus Capital
Since April 6 last year, £580m has been invested in VCTs, a record amount at this stage and a more than impressive show of confidence in the UK’s early-stage ecosystem during a period of considerable upheaval
million
Role of VCTs in portfolios
VCTs are becoming increasingly popular among individual investors seeking to provide greater diversification to their traditional portfolios.
In the current market cycle—characterised by rising inflation, rising rates, and the ensuing volatility—VCTs can play a much-needed role in stabilising and strengthening a well-balanced portfolio. A well-balanced portfolio will have a mix of investment assets appropriate for your risk tolerance and investment goals. As market conditions change, it helps to rebalance your portfolio in a way that responds to the new market dynamics. Financial markets expect more interest rate increases in 2022, as the Bank of England struggles to curb persistent inflation. What’s more, multiple waves of uncertainty that are sweeping the market (of course inflation and high rates, but also the global supply chain crisis, concerns about rising wages, and the Covid-19 variant Omicron) have set the stage for a high level of volatility for the rest of the year.
The FTSE 100 Index
Source: Yahoo! finance, 26 Jan 2022
2022
7,600
7,500
7,400
7,300
7,200
7,100
7,000
Dec
Nov
Oct
7
21
28
7,469.80
Equities: the place to be during inflation
Inflation seems to outweigh even pandemic concerns for both investors and consumers, according to surveys. In this inflationary context, most experts agree that equities are a good place to be. In contrast, savings accounts are losing value. If the inflation rate exceeds the interest earned on a savings or checking account, then the investor is losing money. As for bonds, even if interest rates should begin to rise, the relentless nibbling of inflation would still make them unattractive. So, again, that leaves equities, which have proven their worth in past inflationary environments.
Adding VCTs to improve returns
In this confidence-sapping environment, VCTs can provide a solution. Studies by UK research firm Hardman & Co make a compelling case for venture capital like the VCT to be a normal part of most investors’ portfolios. Adding a VCT to a portfolio was found to significantly improve investors’ risk/return profiles. The researchers found that even for investors with an average risk profile, venture capital portfolio allocation proportions in the mid-teens are beneficial, allaying concerns that VC investors should only be high-risk investors. Further statistical analysis indicates the VCT’s initial tax relief of 30% applied to scale-up investments, will increase expected IRR to 22%, and keep the same standard deviation (i.e., risk level). They conclude that venture capital is almost as good as bonds when compared with equities in regards to diversification. “We show that these tax reliefs hugely improve expected internal rate of returns. Unsurprisingly, these make venture capital even more attractive in our analysis,” the researchers wrote in a white paper. “While there are nuances to applying these adjusted figures in practice, it shows that the original analysis is somewhat conservative.” Brian Moretta, Head of Tax Enhanced Services, said “Perhaps the VCT & EIS industry can move from ‘tax-efficient’ to venture capital with benefits!”
The homogeneity fallacy
People who are uninformed may be forgiven for entertaining the notion that VCTs are all the same: just ‘investment in small UK businesses’. But, as the researchers point out, VCTs and indeed the other venture capital schemes, are far from homogeneous. This multiplicity of sectors, sub-sectors, geographic locations, company size, age, and so on, provides an array of choices for anyone contemplating investing in VCTs, ensuring that every investor could find an option that meets their particular investment objectives. To illustrate the point, the researchers used company’s age, or stage of development, splitting it into two categories: Seed: this is early-stage funding, usually when companies are in product development or finding their first customers. Scale-up: once a company achieves product-market fit, it usually invests in distribution to grow revenue quickly. Funding rounds at this stage are usually known as Series A (or B, C, etc). “There are a myriad of subdivisions of these categories, such as pre- or post-seed, whose meaning is often only clear to those using the term.” Bottom line: every VCT is unique, just as every investor is unique. There are VCTs with characteristics and features for every investor who sees VCTs as a viable investment option, based on their risk tolerance and investment objectives.
- Nic Pillow, Ventures Manager, blackfinch
With so many innovative companies founded during the pandemic, there has never been a better time to invest in the future with VCTs
ince April 6 last year, £580m has been invested in VCTs, a record amount at this stage and a more than impressive show of confidence in the UK’s early-stage ecosystem during a period of considerable upheaval. With investors looking to alternative asset classes like venture capital for returns, pension contributions tightening and an increase in dividend tax rates, it is likely that this figure will only increase year on year. Concentration Risk There is, however, a growing need for diversification. With the average individual investment at £32,000 annually this relatively small portion of an investor’s portfolio is often used to top up the same VCTs. In the 20-21 tax year 52.9% of non-AIM VCT money went into just 4 VCTs out of the year’s 18 offers. This is well reflected in the previous two tax years as well. Investors and advisers alike are inclined to revert to the old adage ‘if it’s not broken why fix it’. It appears the very idea of modern portfolio theory and diversification, which is so widely applied across risk rated portfolios, is being broadly ignored when it comes to a VCT allocation. Investing in an asset class where reliable names hold sway and size infers safety this is perhaps unsurprising, however at an investor level concentration risk is unknowingly rising to levels that would typically set alarm bells ringing. Furthermore, VC portfolios tend to experience concentration risk more acutely than funds with listed equities as a small portion of underlying companies grow exponentially whilst the failures drop out, skewing the portfolio’s weightings towards a handful of holdings. Afterall, the UK has one of the most competitive venture capital landscapes globally so large raises are more likely to contribute to cash intensive follow-ons than newly discovered start-ups. Following on from the rule changes in 2015 and 2017 VCTs are now more in line with ‘risk to capital’ investing, which means that exciting growth orientated companies are the sole focus. The long running bellwethers of the market will slowly dispose of their asset backed and MBO companies and buy early-stage growth companies. This shift in what’s ‘under the bonnet’ has forced investors to increase their appetite to risk. Gone are the days when VCTs operated capital preservation strategies and were looked at solely for their tax reducing merits. They are now a staple part of a sophisticated investors portfolio offering a ‘risk on’ approach and a low correlation to traditional markets. When adjusting for this heightened level of risk and volatility diversification should adjust accordingly. Benefits of investing across multiple VCTs So why would an investor split or alternate their annual VCT subscription? Well, for just the same reasons they would typically invest across a couple of UK Equity Funds, it is standard practice when assessing strategic asset allocation. VCTs have different sets of goals and with those different strategies and styles. They invest in a wide range of sectors from technology to healthcare and media. The Calculus VCT invests across all three of those sectors.. By diversifying across a wide spectrum of the UK’s most successful industries steady returns can be achieved even when one sector is adversely hit. During the pandemic this divergence in sector performance was thrown into heavy contrast as the consumer and retail space came to a grinding halt, whilst the life sciences witnessed a renaissance alongside the continued acceleration of technology companies. VCTs are also more inclined, unlike investment trusts focussing on listed equites, to have a geographic focus to certain parts of the UK. Company deal flow tends to be more localised and post investment the ongoing management more active, requiring close communication, seats on the board and continual oversight. Proximity is broadly recognised to offer long term synergies. Diversifying with a regional predisposition can therefore provide valuation benefits as well as other useful advantages. Lastly, VCT managers tend to look for companies at different stages in their growth trajectory. Some might target established, revenue generating businesses, led by proven management teams, others may look for early-stage entrepreneur led companies with higher growth potential. A blend of both approaches dampens down volatility improving both income stability and the probability of capital growth. Investors should assess this alongside the potential of each portfolio and their ability to make new investments for future growth. It would be prudent to look at whether the VCT has a mix of mature investments ripe for sale -the ultimate objective for a VCT is to achieve profitable exits, thus sustaining the dividend stream. In 2021 the Calculus VCT achieved 7 exits with an average return multiple of 2.3x. As the last few years have shown venture capital makes a compelling addition to a modern, risk managed portfolio, putting UK investors in a particularly fortunate position. We have a range of listed investment companies, with tax reliefs, concentrating solely on the space. However, in an economic environment of seemingly endless growth and increasing asset prices we need to start treating this allocation like any other. Diversification across a number of high-quality generalist VCTs paying attractive dividends is now, with everything considered, the only sensible strategy.
S
oliver warren
Investor Relation Associate calculus capital
thought leadership
VCTs – Time to Diversify
www.calculuscapital.com 0207 493 4940 info@calculuscapital.com
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Blackfinch Calculus Downing Octopus Investments Puma Investments VCT Solutions Comparison
Manager video content
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dr Reuben Wilcock
Head of Ventures
blackfinch.com 01452 717070 enquiries@blackfinch.com
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Nick Priest
businesss development manager
downing.co.uk 020 7630 3319 sales@downing.co.uk
richard lewis
Partner
Video content
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Lewis Kilminster
Business Development Manager
pumainvestments.co.uk 020 7408 4070 advisersupport @pumainvestments.co.uk
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Blackfinch Spring VCT 2013 £643m /£13m Generalist The Blackfinch Spring VCT targets investment into early stage high-growth technology enabled companies with a focus on research & development and innovation, with the potential for high growth and an exit within a reasonable time frame. Nov 2019 Growth & income via tax free dividends New Share Issue Up to £20m, with a £10m over-allotment facility if required Targeting dividends of 5% p.a. from 2024 onwards, along with ‘special dividends’ through earlier exits £3,000 2.50% 2.5%; with 0.5% rebated in order to faciliate any Adviser Ongoing Charges, Execution only Intermediary Ongoing Fees and Direct Investor Ongoing Fees. Any money left over from the rebate will be used to buy additional VCT shares for the investor. 20% performance fee subject to a hurdle of 130p Please see 'Fees and Charges' section of our brochure. For more information on all of our fees, available at the following link*
Calculus VCT 2016 £30m Generalist The VCT provides exposure to a diversified portfolio of smaller, entrepreneurial UK companies, with a focus on the fastest growing sectors in the UK - technology, healthcare and media. The VCT had 7 exits in 2021 which is proof of our ability to back successful businesses. Sep-21 Capital growth and income via tax free dividends New share offer £10million 4.5% of NAV annually £5,000 3% for advised investors 1.75% charged to the VCT 20% subject to a hurdle of 105p
Octopus Future Generations VCT 2000 N/A Generalist with sustainability focus Octopus Future Generations VCT invests in high growth business across three themes; building a sustainable planet, empowering people and revitalising healthcare. The VCT is managed by Octopus Ventures, one of Europe’s most experienced venture capital teams. 2022 Capital growth (and dividends after 3-5 years) - £20 million 5% £3,000 3% Up to 2% 20% + VAT Admin and accounting charge 0.3%
Offer Name Year Founded AUM (total)/AUM (VCT) Type of VCT Description of offer Launch date Investment Objective Type of fundraise Target fundraise Target return/yield Minimum investment Initial fee AMC Performance fee Other fees
Downing FOUR Ventures Downing FOUR VCT was created in 2015 from a merger, the original VCT was founded in 2009 2016 £32.8m/£52.8m (as at 30/11/21) Evergreen This share class will focus on unquoted technology companies in three main sectors: healthcare, deep tech (knowledge intensive) and enterprise. The current fundraise will provide follow-on fundraising for current portfolio companies as well as facilitate investments into new companies. Downing Ventures look to invest in companies with a proven technology and who have a global proposition. Downing Ventures has Venture partners who are located around the world to help source the best deals. August 2021 Provide investors with the opportunity to invest in a range of businesses at different stages in the development life cycle. Provide investors with a regular income through a target annual dividend of at least 4% of its net assets. Prospectus £10m (plus £15m over allotment) No target return/target yield of 4% of net assets p.a. £5,000 into D4 which can be split between 2021/22 and 2022/23 tax years and between share classes. Minimum investment into one share class is £1,000 2.5% for advised investors 2% 20% of dividends paid when total return is above hurdle rate "Administration fees: expected to be less than 0.25% of NAV p.a. Arrangement fees: up to 3% of sum invested Monitoring fees: up to 0.5% p.a. of sum invested" Annual running cost of the VCT are capped at 3% of NAV p.a.
Downing FOUR Healthcare Downing FOUR VCT was created in 2015 from a merger, the original VCT was founded in 2009 2016 £17.0m/£52.8m (as at 30/11/21) Evergreen This share class will focus on investments that will typically be in early and mid-stage healthcare investments including life sciences and bioscience companies, who may already be revenue-generating. The current fundraise will provide follow-on fundraising for current portfolio companies as well as facilitate investments into new companies. August 2021 Provide investors with the opportunity to invest in healthcare and life science businesses at different stages in the development life cycle. Provide investors with a regular income through a target annual dividend of at least 4% of its net assets. Prospectus £10m (plus £15m over allotment) No target return/target yield of 4% of net assets p.a. £5,000 into D4 which can be split between 2021/22 and 2022/23 tax years and between share classes. Minimum investment into one share class is £1,000 2.5% for advised investors 2.50% 20% of dividends paid when total return is above hurdle rate "Administration fees: expected to be less than 0.25% of NAV p.a. Arrangement fees: up to 3% of sum invested Monitoring fees: up to 0.5% p.a. of sum invested" Annual running cost of the VCT are capped at 3.5% of NAV p.a.
Downing FOUR AIM Downing FOUR VCT was created in 2015 from a merger, the original VCT was founded in 2009 2021 nil - brand new share class/£52.8m (as at 30/11/21) AIM This share class focuses on investments that will typically be in revenue-generating, AIM-quoted companies, and has a generalist sector approach. The share class will invest in AIM IPOs and secondary raises of VCT qualifying companies. A minority of investments are also likely to be in companies which are likely to seek a quotation on AIM. Although the investment strategy is sector agnostic, Downing Fund Managers (who manage this share class) will use the sector expertise from inside Downing. August 2021 Initially to use the fundraise proceeds to invest in a portfolio of 15-20 AIM companies, potentially including a minority of companies which are likely to seek a quotation on AIM. Target growth on the portfolio. There is no target dividend policy although it may have the potential to pay dividends in the future. Prospectus £10m (plus £15m over allotment) No target return/no target yield - may look at paying dividends in the future £5,000 into D4 which can be split between 2021/22 and 2022/23 tax years and between share classes. Minimum investment into one share class is £1,000 2.5% for advised investors 1.75% None "Administration fees: expected to be less than 0.25% of NAV p.a. Arrangement fees: up to 3% of sum invested but these don't apply to AIM investments Monitoring fees: up to 0.5% p.a. of sum invested" Annual running cost of the VCT are capped at 3% of NAV p.a.
Offer Name Year Founded AUM (total)/AUM (VCT) Type of VCT Description of offer Launch date Investment Objective Type of fundraise Target fundraise Target return/yield Minimum investment Initial fee AMc Performance fee Other fees
Puma Alpha VCT July 2019 £1.4bn / £99m Generalist Puma Alpha VCT plc is our 14th VCT. It aims to deliver compelling returns through investments in companies that have graduated from ‘start-up’ to ‘scale-up’, while delivering the full range of tax reliefs that come with VCT investing. Relaunched November 2021 Its objective is to deliver the best-possible risk-adjusted returns, so investors experience less volatility and more consistent yields. New share issue £15m with an over-allotment facility of £5 million The VCT intends to pay a regular annual dividend commencing from 2023 (although there is no guarantee). From then on, it expects to achieve an average dividend payment equivalent to 5p per Share per annum (including the 2023 dividend) over the rest of the life of the VCT. £5,000, thereafter in multiples of £1,000 3% (plus VAT if applicable) 2% (plus VAT if applicable) 20% over 120p hurdle or high watermark Annual costs cap of 3.5% of net assets. Refer to Prospectus for full details.
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Calculus VCT 2016 £26m Generalist The VCT provides exposure to a diversified portfolio of smaller, growing UK companies. Sept 2021 The offer will be used to invest in companies with growth potential across the fastest growing sectors in the UK. New Share Offer £10million with over allotment of £5million Target annual dividend 4.5% of NAV £5,000 3% for advised investors (currently 0% fee offer) 1.75% charged to the Calculus VCT 20% subject to a hurdle of 105p
*https://blackfinch.ventures/assets/Blackfinch_Spring_VCT_Brochure_d6d4d33c25.pdf
VCT solutions comparison
Puma VCT 13 July 2017 £1.4bn / £99m Generalist Puma VCT 13 is Puma's 13th of 14 VCTs and builds on the company's 25-year track record of investing in SMEs. Puma VCT 13 invests into businesses that have graduated from start-up to scale-up yet are still small enough and young enough to grow and create meaningful returns for investors. Relaunched September 2021 The company aims to give investors exposure to quality operating businesses with strong management teams in sectors providing structural support for growth. New share issue £25 million with an over-allotment facility of £5m "Targeting average dividend payment in the range 4p to 6p per share p.a., plus potential for special dividends. The Company is also targeting two interim dividend payments between November 2021 and March 2022" £5,000, thereafter in multiples of £1,000 3% (plus VAT if applicable) 2% (plus VAT if applicable) 20% over 110p hurdle or high watermark Annual costs cap of 3.5% of net assets. Refer to Prospectus for full details.
Offer Name Year Founded AUM (tot)/AUM (VCT) Type of VCT Description of offer Launch date Investment Objective Type of fundraise Target fundraise Target return/yield Min investment Initial fee AMC Performance fee Other fees
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High-return investments and the FCA’s quandary
The risk-return trade-off is a fundamental investment principle: the higher the risk, the higher the potential reward. But therein lies the rub. Getting market participants to continuously heed the full implications of this rather troublesome correlation is a constant hassle for regulators everywhere.
Consumers often can’t tell the difference between different types of investments and tend to focus on the promised returns, says the Financial Conduct Authority (FCA). “Investment decisions are highly influenced by emotional and social drivers such as gut instinct, irrational exuberance, sunk-cost bias and perception of other people’s investment success.” To tackle the issue, the regulator has set out on the warpath with a focus on enabling investors to make effective investment decisions and reducing harm. It is without doubt a delicate balancing act. The regulator has to walk a tightrope over the chasm between stifling consumer investment on the one hand and that of failing in its duty to protect investors (including from scams and fraud) on the other. Stated in other words, the FCA’s quandary is obvious: how to protect both investors and the markets? How to erect barriers and not cut off investment into worthy businesses or projects? One thing that is not in dispute is the valuable role high-risk investments play in the economy. “Higher risk investments have a place in a well-functioning consumer investment market. However, we are concerned that some investors access higher-risk investments which do not reflect their risk tolerance and are very unlikely to be suitable for them,” the FCA says. To mitigate this risk, the financial promotion rules apply varying levels of marketing restrictions to financial promotions for certain types of investment. The following graph provides a high-level overview of these restrictions and the investments they apply to.
financial promotion marketing restrictions product categories
The FCA is proposing to require that all financial promotions for ‘Restricted Mass Market Investments’ and ‘Non-Mass Market Investments’ contain a risk warning which says: "Don’t invest unless you’re prepared to lose all your money invested. This is a high‑risk investment. You could lose all the money you invest and are unlikely to be protected if something goes wrong. Take two minutes to learn more."
Warning label
Complicating factors
Developments in today’s market are making the regulator’s juggling act even more complicated. Technology has made investing more accessible for the average person. Consumers have never had so many investment choices as they do today. Those who invest are now only a mouse click away from making changes in their portfolios. Many are skipping brokerage firms altogether. This means that consumers are increasingly responsible for making their own investment decisions. This set of circumstances and complexity unfortunately increases the risk of things going wrong. “We have seen too many examples of consumers searching online for high return savings and investments, investing in high-risk investments and then losing all their money.” More people are investing during the pandemic. “Coronavirus has accelerated some of these trends, with 6% of investors investing for the first time or increasing their holdings of high-risk investments during the pandemic,” according to the FCA. There’s also a flip side. Some consumers who have an appetite to invest long-term are failing to consider the opportunities from investing, missing out on potential financial gains, says the regulator. This means that while some consumers are taking too much risk, others are failing to take enough (reasonable) risk. Even the FCA acknowledges, “We think more consumers could benefit from investing and we want to remove regulatory barriers that prevent access and improve support.”
VCTs can be marketed to retail investors
When it comes to high-risk investment, the FCA’s main preoccupation centres around marketing to retail investors, due to concerns that everyday investors do not properly understand the risks involved. In 2022, the FCA intends to strengthen its financial promotion rules “to help investors make more effective decisions that meet their savings and investment needs”. So far, VCTs have escaped the mass-marketing ban imposed on non-mainstream pooled investments (NMPIs). This is because shares of VCTs are explicitly excluded from the current definition of that category, provided they comply with certain specific criteria, as confirmed by the FCA in Policy Statement 13/3. NMPIs, which include illiquid assets such as forestry, property or loans, cannot be marketed in a way that is likely to be received by a retail client. This exclusion applies to “a company which is, or which is seeking to become, approved as a venture capital trust under section 842AA of the Income and Corporation Taxes Act 1988.” Because VCTs are currently ‘excluded securities’ in accordance with the guidance issued by the FCA, they can therefore be recommended to retail investors by financial advisers. Ultimately, the FCA believes that most retail investors’ needs “can and should be met by straightforward, mass-market investments”. At the same time, the regulator recognises that higher-risk investments have a legitimate place in the consumer investment market for those consumers who understand the risks and can absorb potential losses. However, broadly speaking, the financial promotion regime restricts the marketing of investment opportunities to non-restricted consumers unless the content of the communication has first been approved by an FCA approved firm or person. Despite being viewed by the FCA as high risk investments, shares in a VCT are classified as Readily Realisable Securities because they are listed on the London Stock Exchange. As a result of the increased liquidity and ongoing transparency requirements that this offers, the regulator does not apply any promotional restrictions, but they must still be fair, clear, not misleading and follow the general promotional rules. Nevertheless, in its discussion paper last year, DP 21/1 Strengthening our Financial Promotion Rules for High Risk Investments, the FCA stated, "We want to hear your views on whether there is further harm or potential harm to UK retail investors arising from the mass-marketing of securities which fall within the definition of an RRS.” As yet, no response to the paper, including any views from industry stakeholders, has been published. While the January 2022 Consultation paper CP22/2 makes it very clear that a mass-marketing ban will not apply to VCTs, the FCA is keen to step up prescribed risk warnings for all high risk investments. Of course, where a financial adviser is involved, many of these issues are moot. However, it is in nobody's interests for unsuitable investors to be allowed to invest in any type of fund as it can lead to bad outcomes which then may poison the minds of investors in general to the potential benefits of structures like VCTs, making the job of IFAs more difficult.
- Matthew Moynes, Assistant Director Investor Relations, Calculus Capital
Those investors willing to soak up additional risk may gain exposure to a growth trajectory not accessible through traditional asset classes.
Listed or exchange traded securities. For example shares or bonds traded on the London Stock Exchange. No marketing restrictions.
Readily Realisable Securities (RRS)
Unlisted securities. For example shares or bonds bought through a crowdfunding platform and peer to peer loans. Retail investors generally limited to 10% net assets.
Non-Readily Realisale Securities (NRRS) / Peer to Peer (P2P)
Unregulated pooled investments. For example mini-bonds where the funds raised are used to make loans to other companies. Mass makarketing banned to retail investors
Non-Mainstram Pooled Investments (NMPI) / Speculative Iliquid Securities (SIS)
More restrictions
Source: fca.org.uk
Advice is not reaching all parts of the market
The regulator finds that many consumers struggle with the complexity of investment decisions and may not fully understand the level of risk they are taking. Nearly 57% of adults indicate low financial capability or find it hard to find suitable financial products or services. There is a lack of awareness of the risks of investing, with almost half (45%) of new self-directed investors unaware that ‘losing some money’ is a risk of investing, according to the FCA. Unfortunately, the value of financial advice is not fully appreciated by many investors.
FCA data shows that only 8% of UK adults have received financial advice. Robo advice is failing to fill this gap, with only 1.3% of adults having used this in 2020. The majority (54%) have received no support in making investment decisions. Revenue from adviser charging continues to be dominated by ongoing advice services (76%), with only a quarter (26%) accounted for by one-off advice. Transactional advice is an important service for consumers investing small amounts of money. “Where consumers do receive advice, we continue to have concerns about the suitability of some of that advice. Latest figures show that 17% of DB-DC transfer advice was unsuitable and a further 28% had significant information gaps,” the FCA said. Few consumers have considered the benefits of advice, the regulator added. Nearly 70% (67%) of consumers believe they can make investment decisions themselves and a further 22% have simply not thought about it.
Rebalance Portfolio
Implement Strategic Plan
Review Asset Allocation
investment management process
Assess Risk Tolerance
Determine Investor Needs
Get profit
Source: Kyinbridges
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Britain has become the first major economy to hike interest rates since the Covid-19 pandemic began. In a future dominated by the double whammy of high inflation and rising rates, VCTs have an important role to play.
Inflation jumped to a 10-year high of 5.1% in December 2021, from October’s 4.2%, marking the biggest increase since November 2011. As a result, the central bank’s nine-member Monetary Policy Committee voted 8-1 to raise the Bank Rate to 0.25% from 0.1%. The Bank of England announced the rate increase the day after its enormous bond-buying programme was set to be completed, bringing the total stock of government and corporate bonds it holds to £895 billion. For now, the inflation risk has outweighed growth concerns as the end of Britain’s economic recovery is delayed. Even before the spread of Omicron, the latest Covid-19 variant, the economy was already losing some momentum as supply chain disruptions and product and labour shortages hamstrung companies. This new challenge has added to already heightened concerns regarding loss of purchasing power from cash savings and fixed incomes. Indeed, those holding large amounts in cash savings are particularly at risk from high inflation. The other group particularly affected are pensioners on a fixed income. The state pension is due to increase by 3.2% next April, 1.9% less than where inflation is currently sitting.
Rising inflation and higher taxes—what role for VCTs?
Meanwhile, Bank of England chief economist Huw Pill has confirmed that further rate rises would be likely should inflation persist. He warned that “more domestically-generated inflation here in the UK, probably centred around cost and wage pressures in a tight and tightening labour market, are going to prove more persistent through time.” Mr. Pill’s observation concurs with Bank of England Governor Andrew Bailey’s comments that the outlook for “more persistent” inflation was behind the surprise decision to raise interest rates. With inflation likely to linger for a while, the trick for investors is to position their portfolios to perform well against a backdrop of higher inflation. Traditionally, this has meant a high allocation to equities. On the other hand, rising interest rates can dampen the equity markets, which can lead to lower share valuations as it becomes more expensive for firms to borrow and grow. But VCT investors, who typically have a long-term strategic view, can normally ride out these downtrends . Navigating these treacherous waters calls for some creative, out-of-the-box thinking. That’s why savvy investors are already beginning to rotate at least some money out of some run-of-the-mill investments and into non-traditional options.
“Persistent inflation”
Throughout the pandemic, equity markets have shown surprising resilience to bad news. The worst day for equity markets in 2021 arrived following the emergence of the new Omicron Covid-19 variant (the FTSE100 down 3.6% over 26 November), but markets have recovered strongly to reward equity investors with another healthy positive return over the last quarter of 2021. This concludes a strong year for equity markets as a whole with returns in the region of 20%. But now, worries about the impact of a rise in interest rates on the value of future earnings are here. Some investors will be sticking with ‘growth’ stocks for their long-term potential; others will be shifting into ‘value’ companies who suffered during the pandemic. Both types of investors could benefit from taking a look at alternatives.
The equities market
Historically, the use of non-traditional investing as a hedging strategy has delivered on its role of reducing volatility, with interest rates and inflation taking it in turns to push up liability values for firms and investors. A paradox regarding such non-traditional investments is well illustrated by VCTs. While these investment companies on their own may be considered more high-risk than more traditional investments, they typically have low correlations to, or do not move in lockstep with, more traditional asset classes. This means that their inclusion in an investment portfolio tends to result in lower overall volatility. As such, a modest allocation to such sectors is now considered prudent for more investors than was previously the case.
Off the beaten track
However, in an era when value-eroding inflation and consumption-hindering interest rates are sure to wreak havoc on real returns, it’s worth remembering that not every non-traditional investment is tax-friendly. Indeed, most alternative investment strategies have little to no focus on minimising taxes, an area where VCTs are obviously hard to beat. VCT’s generous tax reliefs are an irresistible lure to many investors, especially now that the tax burden looks set to reach unprecedented levels owing to a combination of tax increases (on the dividend tax and national insurance), heavier restrictions on available tax reliefs, and the freeze on CGT and income tax allowances.
The tax advantage
As well as offering ample tax benefits, VCTs provide investors the opportunity to get a front-row seat to the growth of the UK’s most ambitious early-stage companies. Investing in these early-stage startups offers potential for astronomical growth and outsized returns, relative to larger, more mature companies. The remarkable resilience shown by the VCT sector throughout the pandemic gives reasons to believe that it will continue to thrive in the challenging times ahead.
An exciting universe to invest in
For investors willing to give VCTs a try, the sector provides a great deal of diversity. VCTs invest across various industries. Some VCTs specialise in a given sector, such as healthcare or technology; others invest across sectors. They invest in all regions of the country, in early stage, later stage, and AIM listed companies, providing both diversification and professional management. The result is that practically every VCT is unique. And every suitable investor is likely to find a VCT that meets their own investment objectives.
A greater variety of options
britain's inflation rate
2010
1%
0%
Source: Office for National statistics
2012
2014
2016
2018
2020
3%
2%
5%
4%
5.1%
Year-over-year change in Consumer Price Index
Many early-stage businesses have been forged with strong environmental and social values from the start, making newer VCTs excellent ESG investments compared to legacy equivalents
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The FCA has proposed excluding investment advice from FSCS protection. What would be the implications?
One potential risk of the proposals is in exposing financial advisers to greater liabilities, and consequently pushing up the cost of professional indemnity cover. Advisers may then feel forced to limit the types of investment on which they advise. However, VCT shareholdings are already out of scope of the FSCS, so VCT investments may become relatively more attractive.
Regarding VCTs, what are your predictions for 2022? What factors will be crucial for the sector?
With people increasingly looking to the future after a turbulent couple of years, we expect strong investor inflows into VCTs, especially those focused on innovative newer companies with clear ESG credentials. VCT managers in turn must ensure they recognise recent changes and deploy funds into the exciting companies that can help define our new world.
The head of the World Health Organisation says 2022 could mark the end of the pandemic. Looking ahead, what lasting impact will Covid-19 have on the VCT sector?
Many negative effects of the pandemic are likely to reverse as we emerge from it. However, the boost to technology has been an acceleration of an existing trend likely to persist. Many VCTs focus on the technology sector, and they will have a bright future in supporting the dynamic new businesses that help shape and enhance our post-pandemic lives.
It could be argued that the process to get an alternative investment such as a VCT or EIS onto a recommended panel may endure a higher level of due diligence. Advisers may also feel the need to adjust their professional indemnity policy limits to reflect the additional liability. Overall, it’s a change that will force greater responsibility on the doorstep of advisors, a move the FCA hope will increase accountability for poor advice, but for some, they will see this to be at the expense of the client’s protection.
Since the launch of the first VCT back in 1995 evolving legislation has driven material changes in the fundamentals of this investment product. These changes have steered the VCT towards a sophisticated and credible alternative investment product which continues to grow in popularity amongst UK investors. We have seen shift away from capital preservation investment strategies targeting asset backed securities and lower risk Management Buy Outs, and a move towards high growth, risk to capital assets, in line with the true spirit of VCT investing. With record fundraising across the VCT product set and greater capital to deploy, managers will inevitably expand their geographical boundaries and provide essential capital to regional entrepreneurs which historically have been largely overlooked. The VCT is fast becoming an enviable investment vehicle which international markets will look to replicate.
The VCT market as whole has proven itself to be incredibly resilient and robust in the wake of the pandemic. VCT Managers and the underlying portfolio companies demonstrated exemplary collaboration in their efforts to prepare for the anticipated economic fallout of the pandemic. What transpired was a welcome surprised for most. Certain sectors and companies thrived because of a dramatic shift in behavioural patterns and fundraising and exits certainly didn’t grind to a halt like some may have expected. Battle hardened, the community of VCT Managers have earnt greater trust and support of investors and this will be demonstrated through further years of record fundraising.
The FCA want to get to a state where the FSCS is not over relied upon to deliver consumer protection, but instead acts as a final backstop to protect consumers in certain situations when all other mitigants have been exhausted. The FCA considers that reliance on the FSCS under its current mandate, may create perverse incentives for both firms and consumers. They are looking for Firms to pay for poor advice rather than the FSCS and expect firms to ensure that the conditions are in place such that consumers' biases are not exploited, they are able to make informed decisions, and are therefore able to take responsibility for the decisions they make following their dealings with authorised firms. Implications : - the FCA expects firms to have adequate financial resources and, as appropriate, adequate insurance in place to meet the cost of liabilities that may arise. If a firm cannot continue to trade, we expect firms to wind down in an orderly way and pay all their liabilities rather than to fail and enter an insolvency process – and without the need for compensation from the FSCS where possible. We are awaiting the New Consumer Duty regulations policy statement at the end of July 2022, which should provide more clarity.
As has already been seen in the record fundraising season to date, VCTs are more popular with investors than ever and I would expect the growth in fundraising to continue (even if not to the levels of this year again, which may have been driven to some extent by stored up capital during the pandemic being released as confidence in the future has grown). However, as a result of this, there are a number of the larger VCTs with large cash positions requiring deployment, leading to more funds chasing a finite number of deals. Firms, such as Downing, with EIS funds investing in earlier stage investments may benefit from the ability to follow those rounds with their VCTs, whereas those without such extensive portfolios may struggle to get access to some of the more attractive opportunities.
The EIS and VCT market have generally weathered the storm of the pandemic reasonably well. Some VCTs suffered early losses when the first lockdowns bit, but most have recovered that lost value and more since then. Certain sectors, such as Healthcare, and certain companies, such as those supporting the move to more flexible working, have seen strong interest and performance but broadly speaking it is still agile companies with strong propositions that have benefitted and we expect that to continue.
tom mullard
Excluding investment advice from protection might mean investors demand more transparency and proactive communication from the financial institutions they invest with. At Octopus we are proud to have excellent customer experience as one of our core focuses and we will continue to work with our advisers to deliver that to their clients and our customers.
We have seen excellent deployment opportunities in the smaller companies sector this year, along with positive support and interest from investors keen to back smaller enterprises. As we emerge from the pandemic, smaller companies will be important in disrupting outdated industries, creating opportunities for investors to join their growth journey as long as they are comfortable with the risk.
The pandemic has accelerated tech adoption and tech led solutions to customer problems, so it’s likely that tech will continue to be a major factor in VCT investment. Lockdowns and isolation have also led many founders to realise the importance of connectivity with each other, these networks will be important for deal sourcing and supporting entrepreneurs on their growth journey.
That would limit even further the number of people who have VCTs recommended to them by an advisor. This would increase the imbalance driven by our regulatory landscape whereby the rich can access private company investment (often in a tax advantaged way) and – other than through a VCT – the relatively less well-off cannot. If people are to be able to save effectively for their retirement, they need to have access to the tools with which to do so.
The economy is facing numerous challenges in 2022; inflation will squeeze discretionary spend whilst interest rate rises put strain on valuations, but there remains a lot of deployable capital in the system. VCT managers will need to exhibit real discipline on pricing if they are to build portfolios that can deliver returns over the next five years.
As the pandemic took hold in 2020 investment activity shut down. In 2021, that meant there was a surplus of capital chasing each opportunity, and VCT managers who invested heavily had to give up pricing discipline and do so at very high valuations. That makes it likely that there will be a cohort of poor return performance in three to five years which, reputationally, could impact the sector.
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Learning objectives
How did you do?
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Covered in Section 4: Industry Analysis
Define the typical charges investors can expect with VCT
Identify the main themes and trends in the VCT market
Covered in Section 3: Considerations for Investment
Evaluate VCT performance in 2021
Explain how potential tax changes might affect the appeal of VCTs
Covered in Section 4: Industry Analysis and Section 6: What’s on the Horizon
Describe major legislations and their impact on VCT
Covered in section 2: Market Updates and Section 6: What’s on the Horizon
Analyse the role of VCT in the era of rising inflation, interest rates, and taxes
Covered in Section 6: What’s on the horizon
CPD and feedback
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This publication has achieved accredited status from the CII and PFS. Members of these professional organisations represent the majority of the insurance, investment and financial services industry.
Readers of the VCT Quarterly Update can claim up to two structured CPD hours towards their CII or PFS member CPD scheme for the time spent reading this Update (excluding breaks). The review process included an assessment of the technical accuracy and quality of the material against CPD Accreditation standards. Achieving the recognised industry standard afforded by these organisations for this Update, and our training, demonstrates our commitment to delivering only balanced, informative and high quality content to the financial services and investment community. In order to test your knowledge and obtain a CPD certificate readers will need to complete a short online test and provide feedback on the update. This includes 10 multiple choice questions to demonstrate learning and a feedback form to assist in the compilation and improvement of future reports. To claim your CPD visit: intelligent-partnership.com/cpd
Intelligent Partnership actively welcomes feedback, thoughts and comments to help shape the development of these Quarterly Industry Updates. Greater participation, transparency and fuller disclosure from industry participants should help foster best practice and drive out poor practice. To give your feedback please email: publications@intelligent-partnership.com
About intelligent partnership
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disclaimer
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This publication is not included in the CLA Licence so you must not copy any portion of it without the permission of the publisher. All rights reserved. No parts of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means including electronic, mechanical, photocopy, recording or otherwise, without written permission of the publisher. This publication contains general information only and the contributors are not, by means of this publication, rendering accounting, business, financial, investment, legal, tax or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional adviser. Neither the contributors, their firms, affiliates nor related entities shall be responsible for any loss sustained by any person who relies on this publication. The views and opinions expressed are solely those of the authors and need not reflect those of their employing institutions. Although every reasonable effort has been made to ensure the accuracy of this publication, the publisher accepts no responsibility for any errors or omissions within this publication or for any expense or other loss alleged to have arisen in any way in connection with a reader’s use of this publication. This publication is based on the authors’ understanding of the structure of the arrangements detailed, the current tax legislation and HM Revenue & Customs practice as at February 2022 which could change in the future. It is not an offer to sell, or a solicitation of an offer to buy, the instruments described in this document. This material is not intended to constitute legal or tax advice and we recommend that prospective investors consult their own suitably qualified professional advisers concerning the possible tax consequences of purchasing, holding, selling or otherwise disposing of VCT-qualifying shares. Intelligent Partnership is not authorised and regulated by the Financial Conduct Authority and does not give advice, information or promote itself to individual retail investors. It is the responsibility of readers to satisfy themselves as to whether any arrangement contemplated is suitable for recommendation to their clients. Tax treatment depends on an investor’s individual circumstances and may be subject to change. Certain investments carry a higher degree of risk than others and are, therefore, unsuitable for some investors.
