Investing in an ISA is an annual ritual for many investors.
But if you’re in the fortunate position of maxing out your ISA allowance, or you have a particularly large tax bill this year, you might want to consider a Venture Capital Trust (VCT).
Why consider VCTs?
VCTs are a type of investment trust that invests exclusively in small, fast growing UK companies. Last year over 40% of VCT investee companies grew sales by more than 25% year-on-year, far faster than the UK’s main market of listed companies.
To encourage investment in these fast growing, but high risk companies, the government offers VCT investors generous tax reliefs – including 30% income tax relief up front and tax free dividends.
In a world where the tax burden on wealthier individuals is increasing all the time, that is potentially very appealing.
Who should consider VCTs?
Investing in small companies is higher risk, and on top of that VCT rules mean investors have to remain invested for at least five years if they want to qualify for tax relief.
The combination of higher risk and longer investment horizons means VCTs tend to be more popular among more experienced investors who already have a conventional investment portfolio.
They are able to take the increased risk and tie money up for an extended period. They’re also more likely to have a sizeable income tax bill to offset – so benefit most from a VCT’s tax saving side effects.
A beginners portfolio for VCTs?
As with any investment, diversification is key when investing in smaller companies – and while all VCTs invest in a portfolio of different companies, backing a selection of different VCT managers can help to diversify investors across a range of underlying markets.
The below is an example of the kind of portfolio a first time VCT investor could build – based on a £35,000 overall investment (the average annual VCT investment among Wealth Club clients). It would spread their money across around 200 small British businesses – including both private companies and those listed on AIM.
A £35,000 VCT portfolio
- Albion VCTs – £10,000
- Baronsmead VCTs – £10,000
- Pembroke VCT – £10,000
- Triple Point Venture VCT – £5,000
Commenting Nicholas Hyett, Investment Manager at Wealth Club, said, “When investing in small companies, diversity is key. Small companies are more likely to fail than larger ones, and having all your eggs in one basket increases the risk of significant financial losses.
By diversifying your investment you not only reduce that risk, but also increase the chance you hit a winner. And often in venture capital just one or two investments will end up delivering the vast majority of overall returns.
Picking just four VCTs can give you an underlying portfolio of a hundred of companies or more. By spreading your investment across multiple VCTs, you diversify the type of companies you back too – since different VCT managers tend to have expertise in different sectors.
For example, the manger of Pembroke VCT has particular expertise in more consumer exposed investments, whereas the Albion VCTs have enjoyed particular success in B2B software businesses. The smaller Triple Point Venture VCT specialises in backing companies at an earlier stage in their development – where the risks might be higher but the potential upside is also all the greater.
A £35,000 investment could entitle investors to up to £10,500 of income tax relief upfront, as well as tax free dividends. However, it’s worth bearing in mind that VCT fundraises have limited capacity, and once they’re full, they’re full. Popular fundraises can, and do, fill quickly, particularly as we approach the tax year end.”
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