ASK THE EXPERT: Harry Driscoll of Chelsea Financial Services explains why VCTs can be so attractive, and offers some ideas for investors interested in this area
Holly Cook: Welcome to the Morningstar series Ask the Expert. My expert today is Harry Driscoll, he’s a senior research analyst at Chelsea Financial Services.
Harry, thanks for joining me.
Harry Driscoll: Thank you.
Cook: So we are going to talk today about VCTs, but first off we should really talk about exactly what they are. Could you explain briefly for us?
Driscoll: Sure. VCTs or venture capital trusts are a long running initiative supported by successive governments to encourage retail investors to invest in small, typically unquoted but not always, UK companies. A VCT is structured much like an investment trust with typically 20 to 40 underlying investments, but the underlying investments must satisfy certain investment criteria. Provided those criteria are met investment into the VCT will attract various tax breaks. The main one of which would be the 30% income tax relief provided that the investment is held for five years, but also capital gains are also exempt of tax and any dividends paid are exempt from income tax.
Cook: Ok, so that sounds very positive, what’s the kind of key risk that investors need to be aware of?
Driscoll: Well obviously the underlying companies are very small and are very sensitive to any changes in the macroeconomic environment. Complete failure is not an unrealistic possibility. So that is certainly something to bear in mind for investors. Given the investment criteria attached to VCTs, VCT managers have sometimes limited flexibilities when they can sell out to these investments. So in times of market stress they might not be able to sell which could mean, perhaps like in 2008, these vehicles can be very volatile.
Also the VCTs themselves because in the primary market there is all these generous tax breaks, in the secondary market there isn’t, the VCTs themselves can be quite illiquid and trade at quite significant discounts to the net asset value. While some of the groups are looking to improve this by having buyback policies, the reality is you will have to exit after the five-year period at some sort of discount.
Cook: So for an investor who appreciates the pros of potentially buying into VCTs but understands those risks and is willing to have a foray into this area, you’ve got a couple of VCTs that you think might be worth looking at. What would be number one on your list?
Driscoll: Sure. There are three main categories of VCTs. There is generalist VCTs who typically invest in unquoted [companies]. There is limited life, who look to return the money to you after five years. And there’s AIM VCTs who invest in listed investments. I thought I’d give you an example of each today.
Driscoll: The first of which is ProVen VCT (PVN) that’s a generalist VCT as I mentioned earlier, which invests primarily in unquoted companies. ProVen historically have had a bias towards the digital media sector although it is worth noting they do look at other sectors. They have got a very stable and strong investment team, and over the last 10 years the investment returns have been very, very good. I think they’ve returned – well they have returned £3.47 per £1 net investment over the last 10 years.
Cook: That’s really substantial.
Driscoll: It works out around 13% per annum compound return, although it is worth noting that that those returns were not evenly distributed over the period.
Cook: So there was a bit of volatility there.
Driscoll: Certainly yes. Some of the years they have very good years, some of the years they have bad years and that’s why they’re long-term investments, you’ve just got to hold on to them. And also ProVen also have an industry-leading 5% buyback policy, which means if after the end of the five-year period you want to get out, you can typically at the moment get out they’ll buy your shares back off you at a 5% discount to NAV.
Cook: So that is always reassuring for an investor.
Cook: So what would be number two then?
Driscoll: Well, number would be the Puma range of VCTs. The one that’s currently open is Puma 10. Puma are a limited life VCT, which means they’ll look to return or seek to return the money to you after the five-year period is over. Obviously there is no guarantee of that. The manager, Shore Capital, employes a proven asset-backed strategy where they provide loans to VCT-qualifying established businesses in the form of senior secured debt. This means they don’t sit behind any banks and in the event of default they have rights over some of the assets of the company.
After year two, they will attempt to pay out a 6 pence per year dividend off a £1 float price and after the five-year period anything that’s leftover they’ll seek to return to you. To give you an idea of the sort of returns you might be able to get, Puma 5 – which was recently wound up – has just returned £1.06 per 70p net investment which works out at round about 8.7% compound return per annum. While VCTs should all be considered high risk, Puma, because of the asset-backed nature and secured nature of the debt, is at the lower end of the risk spectrum.
Cook: Something reassuring again, for those investors looking here.
Cook: And what would be number three than on your list?
Driscoll: Number three, as I mentioned there’s AIM VCTs, and Hargreave Hale is a small-cap manager – actually one of the most established small-cap boutiques in the country. And the VCT itself is co-managed by Giles Hargreave, who’s one of the well-known small-cap managers whose flagship vehicle is Marlborough Special Situations. They run two AIM VCTs [HHV & HHVT]. An advantage of AIM VCTs is, one, at the moment the AIM market is currently very vibrant. And another advantage would be the superior liquidity as opposed to their generalist counterparts; some of the companies within the VCT have grown over the last five years, an example would be Abcam (ABC) that is held in their portfolios and that has a market cap well in excess of $500 million. And also there is greater transparency with the way the underlying investments are priced because the prices are set by the market.
Hargreave Hale itself they tend to pay out 5% of the net asset value in dividends per annum but you may well see significant growth in the net asset value as you did last year when the AIM market was up 30%. And Hargreave Hale also have a 5% buyback policy so you should be able to get out after the five-year period at a reasonable discount.
Cook: Well that’s very interesting information for our investors to go away and do their own research. Thanks very much Harry.
Driscoll: Thank you.
Cook: For Morningstar I’m Holly Cook. Thanks for watching.
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