VCTs offer plenty of tax perks and one now offers a monthly savings scheme

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Investors are being given their first chance to invest in a venture capital trust (VCT) on a regular monthly basis following the launch of a £70 million fundraising by Octopus Titan VCT. This helps individual investors to invest regularly in a tax-efficient way and is also good for the VCT, which tends to get most of its cash just prior to the end of the tax year.

Direct debits will be used to take money out of the investors' bank account each month and Octopus Titan will issue new shares at a small discount to the prevailing net asset value (NAV) every three months.

The minimum monthly investment is £1,000 compared with a £3,000 lump sum minimum. In August 2017, investors will be asked if they want the direct debit to continue. Many conventional investment trusts already offer monthly savings schemes, some enabling a regular investment of as little as £20 a month, but these funds do not offer the same tax benefits as VCTs.

WHY VCTS?

VCTs were set up two decades ago in order to provide investment for small, growing companies, which may have been hard to come by elsewhere.

This means that they are higher-risk than most of the other investment trusts that are also listed on the main market of the stock exchange. However, they do offer a spread of investments, so are less risky than investing directly in one or two specific start-up companies.

VCTs have to invest 70 per cent of their funds in qualifying investments, which means that these investments cannot be listed on the main market and they have to be in specific sectors that are allowable under the tax rules.

For example, property-based investments do not qualify. This has to be done within three years of raising the cash.

There are also requirements about the maximum size of a company and number of employees, while the rules have been tightened up to ensure newer companies receive the investment rather than companies that have been going for decades.

Although the underlying investments have to be 'unquoted', Aim and ISDX-quoted companies still come under that label in terms of the Treasury rules, so there are a number of Aim-focused VCTs.

Another key requirement is that the VCTs have to buy new shares in a company. VCTs can buy existing shares, but they do not count towards the 70 per cent of qualifying investments.

There are a number of tax benefits for individuals investing in new shares in VCTs. The initial benefit is that 30 per cent of the investment can be offset against income tax in the tax year that the investment is made.

The investment has to be retained for five years in order to obtain the full tax relief or else all or part of it will be clawed back by the Treasury - the proportion will depend on how long the shares are owned before they are sold.

Dividends are tax-free and so are capital gains. If you buy shares in the market then dividends and capital gains are still tax free, but there is no income tax relief.

VCTs can offer some attractive yields that investors would be hard pressed to find elsewhere. Yields of 5 per cent or more are common, although yields in any one year can be affected by special dividends.

POPULARITY RISING

Last year was a bumper one for new VCT fund-raisings, with £458 million raised in 2015-16, up from £429 million the previous year. This is the third-highest amount in 20 years. In 2004-05, £505 million was raised and in 2005-06 £779 million was raised.

There are 76 VCTs in operation and they have assets of nearly £3.6 billion. That is less than 3 per cent of the assets of all listed investment companies, even though VCTs account for one-fifth of the number of companies.

This shows how much smaller the average VCT is than conventional investment companies.

The number of VCTs has fallen in recent years because there have been a number of mergers in order to increase the funds under management and reduce costs. Octopus Titan itself has reached its current size through the merger of five VCTs under the Titan brand into one.

Individual VCTs sometimes have more than one share class, but the management costs are spread across all of the share classes. For example, Edge Performance VCT has seven share classes ranging from C to I, but the total asset value is less than £50 million.

Octopus Titan is the largest VCT by far, with more than £300 million of assets - more than 8 per cent of the total value of VCTs. The next biggest is less than three-fifths of its size.

There are three main types of VCT: Aim; generalist; and specialist sectors, including environmental, healthcare and technology. The sector-focused VCTs are less favoured than they used to be and many have become generalist or merged with a generalist VCT.

Generalist VCTs account for more than two-thirds of VCT assets and Aim VCTs for about one-sixth of them. Specialist VCTs investing in renewable energy have been popular in past years, but the additional benefits have been limited by the government.

Investment in VCTs is not free. There tend to be initial charges of 3 per cent, or 5.5 per cent if an intermediary is used. There is an annual charge of 0.3-0.5 per cent of NAV.

The offer price for the Octopus Titan shares is 94.5 per cent of the official NAV, which is announced every six months, when they are issued.

Octopus Titan and other VCTs that do not predominantly invest in companies that are quoted on Aim and ISDX have to estimate the value of their shareholdings because they are unquoted.

They could use the most recent share price at which funds are raised or a formula based on a multiple of profit. This means that the real value cannot be guaranteed.

BIG DISCOUNTS

Most, but not all, VCTs trade at a discount to their NAV. According to the Association of Investment Companies the average discount is 7.8 per cent.

Discounts can become much wider because of the lack of trading, particularly where the five-year period has not been reached for share issues. Fund managers are aware of this and there are share buybacks and other ways of reducing the discount.

Another thing to look out for is the bid/offer spread. Shares in smaller companies can have wide bid/offer spreads, but an investment company might be expected to have a narrower spread. That is not necessarily true of VCTs.

Of course, if you are holding the shares for five years in order to get the maximum tax relief then this is not of immediate importance, but it may become important in the future.

Spreads will change, but will not necessarily get better - so if they are large now, they could be large in five years. Share buybacks can also be used to help narrow the spread.

At the end of August, Edge Performance consolidated six share classes into I shares, but historically these share classes had varying discounts depending on the class of share - the C shares had a spread of 3.5p/5.5p.

The mid-price represents a premium to NAV, but the bid price is nearly a 20 per cent discount to NAV. Admittedly, the asset value of the C shares was small, which, along with past poor performance, exacerbated this effect.

Even a bigger VCT can have a relatively wide spread. British Smaller Companies VCT 2 has assets of more than £55 million, but its bid/offer spread is 56p/60p on top of a discount to NAV of 7 per cent. The underlying discount is widened to more than 10 per cent.

OCTOPUS

Octopus Investments is the biggest VCT-focused fund manager and it has £651 million of assets under management - Octopus Titan holds nearly half of those assets.

Octopus Titan is a generalist VCT and it tends to make initial investments of between £100,000 and £5 million in a single company, followed up by further investments as progress is made.

Past investments include easier typing app developer SwiftKey, which was recently sold to Microsoft, enabling the fund to pay a special dividend, and healthy snacks supplier Graze.

The top 10 investments account for three-fifths of the portfolio, excluding cash holdings, although this does include a significant investment in a holding company, Zenith, with an investment in a fund with stakes in more than one investment.

Octopus Titan has a relatively narrow spread of 88.75p/90.75p. The mid-price discount to NAV is around 5 per cent. Total dividends of 61p a share have been paid over the years and the current yield is 4.4 per cent.

Octopus Titan is the fifth best VCT performer over five years in terms of NAV cumulative total return, with £100 invested worth £164.10. This compares with an average performance for all VCTs over that period of £131.30.

Over three years the VCT is the twelfth best performer and there is a small outperformance when compared with the VCT sector. This suggests that Octopus Titan is a reasonably consistent performer with potential exits for older investments.

The new regular VCT savings scheme has been compared to regular investment in pensions, but it is likely to be much more risky than the majority of people's pension investment. It does offer a supplementary way to save for retirement, though.

In view of its size and performance, Octopus Titan appears to be a fund suitable for regular investment and there may be other large VCTs that offer this form of investment.


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