The number of people benefitting from VCTs is increasing just as the alternative investments are becoming better understood and their appeal is rocketing
VCTs are becoming a more obvious investment choice for an increasing number of high earners just at a time when they are ‘coming of age’.
The appeal of VCTs continues to grow and last year, Association of Investment Companies (AIC) data showed that the alternative investment vehicle had raised £728 million in the 2017/18 tax year, a huge 34% rise on the £542 million raised the year before, and the highest ever amount raised at the current level of 30% upfront income tax relief.
Before last year, the largest sum raised was £779 million, when the initial tax relief on investments was 40%.
As of 5 April 2018, the amount of assets under management in VCTs totalled £4.3 billion, showing the appetite for the investments is significant.
The investments had a further boost from the government’s Autumn Budget last year, according to Annabel Brodie-Smith, Communications Director at the AIC.
She noted the Budget reiterated VCTs place as ‘an effective provider of patient capital’.
‘There’s a lot to be excited about in the VCT industry, let alone the companies that bring it alive,’ she says.
While the backdrop, and government attitude towards VCTs, is all positive, there is still a relatively small number of people using VCTs, and plenty of people missing out on the investment opportunities as well as tax relief.
David Lovell, Operations Director at Growthinvest, a platform that provides access to tax efficient investments, said while the funds have seen record years, ‘I firmly believe there’s a much bigger audience among high-net-worth investors and the number is relatively small’.
With many problems in financial services, the problem boils down to education, both on the clients part and the advisers part. But circumstances dictate that more clients than ever will need to, and be willing to, access alternative investments.
Lovell says for some clients ‘VCTs aren’t right for them or they’re not comfortable with the level of risk’ but despite this there is ‘still a need for further education for investors and advisers that these tax schemes are there and they’re government-backed’.
One of the biggest boosts for VCTs has been the reduction of the limits on pension contributions. The lifetime allowance has been cut from £1.25 million to £1 million, meaning high earning investors have had to find new ways to fund their retirement without incurring large tax charges, and are therefore making VCTs a core part of their retirement plan.
‘We’re seeing more and more advisers coming to us saying they’ve not done this before, but they need to as they have higher-rate taxpayers approaching their pensions limit, and if they don’t mention this as an alternative, someone else will,’ says Lovell.
‘There’s a lot of great information out there and advisers are realising that they need to get into the marketplace.’
While VCTs are of interest for high-net-worth investors, VCT industry experts and advisers both agree that they are not a substitute for pensions.
John Glencross, Chief Executive of Calculus Capital, says his experience is ‘knowledgeable advisers are looking at [VCTs] as a companion to pensions’ rather than an alternative.
He believes there are many people out there at the moment who do not even know they need an alternative to their pension as they are unaware of the pension allowance changes.
‘A lot of people, without even being aware, have gone through that and I don’t think the government warned people enough to check the limits on their pensions,’ he says.
‘They could have claimed certain allowances at the time in terms of where they came into the system but, if they didn’t, they just suffered the consequences.’
He adds that the punitive treatment of buy-to-let investing will also push individuals towards VCTs, as well as the low interest rate environment.
‘We’ve been in a low interest rate environment for some time, but the thing about VCTs is that they pay attractive levels of tax-free dividends,’ says Glencross.
‘If someone has assets but a certain amount of cash, which they’re paid practically nothing on – you see people rushing in to get a latest bank [account] offer – and the thing about VCTs is that, on average, they pay a 4.5%-5% tax-free dividend… that’s a very attractive level of return for the higherrate taxpayer.’
All the signs point to VCTs being an attractive investment: capital returns, tax-free dividends, tax relief upfront, and government-backing, some advisers still remain wary of the sector.
Tony Catt, Compliance Officer at TC Compliance Services, says advisers should introduce VCTs as ‘a positive alternative investment’. However, he admits that the tax relief can be a ‘hurdle’ as VCTs are known just for the tax relief rather than as an investment in their own right.
‘Advisers need to remember that clients want capital retained so they’re not wanting to put it into a blackhole,’ he says.
‘They need to see it as a positive investment as an an alternative once you’ve run out of your pension allowances. It should be the first stop after that.’
However, Catt notes that not all advisers can advise on VCTs, even if they want to, because of restrictions placed on them by their networks.
‘As far as advisers are concerned, a major issue is dependent on where they actually operate,’ he says. ‘If they operate within a network, the networks are scared of VCTs.’
However, Catt adds that directly authorised advisers can ‘do what they like’ but ‘they say [VCTs are], on the risk scale of one to six, would be 21’.
Many advisers will be still be convinced that VCTs are risky but a good understanding of the underlying investment in the VCT can help take away some of the fear factor of recommending them.
‘We have highlighted the tax benefits, they’re significant,’ says Glencross. ‘But I do feel that it’s also important that the adviser and the client feels comfortable with what’s going on under the bonnet. What’s being invested in?
He says once advisers understand what investments are underpinning the VCT, they ‘tend to be enthusiastic’.
‘I sat next to an IFA at an event and he said what was most important to him is wanting communication from the fund…on the nature of the investments and how they’re doing because clients love involvement,’ he says.
‘Tax relief is fantastic but there’s an issue with getting advisers comfortable with the risk, but let’s get to what the industry does, it invests in incredibly interesting companies, some that are potentially world class.’
Glencross says VCTs have ‘come of age’ and managers are capable of ‘taking out some unnecessary risk’ while capturing the gains.
‘We can talk about the amazing tax benefits, but we need to show that we have some incredible investments being made,’ he says.
Promoting the underlying companies, and the benefits they have to the UK economy, is something that should happen more.
Brodie-Smith says the companies are bringing VCTs ‘to life’ and client interest doesn’t stop at putting money into them.
‘They’re interesting companies, but also a lot of people who’ve been involved in running companies like the interaction with the chief executive and like to see where their money is going to help,’ she says.
‘It’s also about economic benefits for the UK.’
Not only that, but VCTs are proving their worth with their returns. Brodie-Smith says the average VCT was up 147% over 10 years and ‘that’s not even thinking about tax relief’.
Understanding the risks of investing in VCTs does not mitigate the fact that investing in early-stage companies is inherently more risky than a more standard investment.
‘These are early stage companies and have a higher risk profile,’ says Glencross. ‘But if you look at some big companies in the last 10 years, you might dispute that.’
He adds that most VCT portfolios invest in 40 to 50 companies so they are ‘diversified portfolios’ and VCT managers and their portfolios have ‘come of age’.
‘If we take into account the tax risks and the incredible nature of the companies and the fact that the VCTs have come of age, most VCT managers have been in business for 20 years and know what they’re doing,’ he said.
Brodie-Smith adds that advisers and clients also have the ‘reassurance that [VCTs are] a listed company subject to company law and listing rules with an independent board to oversee what’s going on’.
‘I think that structure should give investors a lot of reassurance,’ she said.
Madeleine Ingram, Head of Investor Relations and Marketing at Calculus Capital, says an IFA she had spoken to while looking at VCTs from a tax perspective was ‘also looking at asset diversification’ and that investing in a VCT would provide access to small UK companies, which his client did not already have.
Lovell says advisers are ‘not just diversifying with one manager, many go into multiple VCTs each year’.
‘We have one who has been investing into VCTs for 20 years and invests in at least two or three each year, so each year they will have that further element of diversification and potentially reaching over 100 companies with three investments,’ he says.
As well as diversifying by spreading client money across a number of VCTs and using VCTs as a companion to pensions, Glencross says advisers should be looking at using EIS as a companion to VCTs.
‘We’re talking about VCTs but there’s another tax dvantaged product, EIS, and I’ve sat in meetings where it’s felt competitive but they go comfortably together,’ he says.
Advisers should consider VCTs for older clients in particular because they have a need for income, which investors can get via tax-free dividends, which Glencross says is ‘attractive’.
‘For the retired investor, if appropriate within their portfolio, it can be a good source of additional income,’ he says.
‘For the older investor, VCTs don’t have inheritance tax relief, so there’s a place for the older investor to look at both as with the EIS will come inheritance tax relief.’
‘It’s interesting to see younger investors coming into VCTs; they’re at an affluent point in their lives and the tax relief is very attractive,’ he says.