Second-hand VCTs are unloved and rarely traded. Yet generous tax-free yields are available for those who can handle the risk.
You'd think Venture Capital Trusts (VCTs) would have enjoyed their moment in the sun by now. These specialist investment trusts have all the key ingredients for a private investor fad – a sexy focus on start-ups and/or private equity, income tax relief on initial purchases, tax-free dividends…
…and amazing returns? Ah. That's what's missing.
What are VCTs?
VCTs are typically small-to-tiny investment trusts, traded on the stock market. Besides their special tax benefits, they also stand out for the big fees they charge investors compared to conventional investment trusts, and their decidedly mixed track record.
Perhaps the timing hasn't helped. The first round of VCTs got caught in the fallout from the tech bubble, with many of the riskier start-up orientated trusts suffering particularly badly.
Now the more recent crop (VCT investment bulged for a period when the Government juiced the incentives a few years ago) are seeing their portfolios maturing in the middle of the worst recession for three decades.
Yet throughout, the best of the so-called 'generalist' VCTs -- which offer the closest thing to conventional private equity funds -- have carried on investing in promising small companies, realizing their investments and paying out dividends, as the table below indicates.
The table ranks generalist VCT funds by their total return over the past five years. Total return is defined as Net Asset Value (NAV) plus cumulative dividends paid.
| VCT | 5-year return (p) | Share price (p) | Latest pub'd NAV (p) | Date of latest NAV | Discount to NAV | Latest annual divi (p) | Tax-free yield |
|---|
| Proven Growth & Income | 167.80 | 51.0 | 60.1 | 30-Nov-08 | -15.1% | 26.00 | 51.0% |
| Albion Development VCT | 147.70 | 67.5 | 82.0 | 31-Mar-09 | -17.7% | 12.00 | 17.8% |
| Northern Venture Trust (Ord) | 141.30 | 54.0 | 76.2 | 31-Mar-09 | -29.1% | 7.50 | 13.9% |
| Baronsmead VCT 3 | 137.20 | 91.5 | 103.6 | 31-May-09 | -11.7% | 7.50 | 8.2% |
| Proven VCT | 135.80 | 45.0 | 58.7 | 30-Nov-08 | -23.3% | 9.75 | 21.7% |
| Baronsmead VCT 4 | 128.40 | 84.3 | 94.9 | 31-May-09 | -11.1% | 7.00 | 8.3% |
| Baronsmead VCT | 126.50 | 65.5 | 74.1 | 30-Apr-09 | -11.6% | 8.00 | 12.2% |
| Baronsmead VCT 2 | 122.40 | 78.5 | 89.9 | 30-Apr-09 | -12.6% | 7.00 | 8.9% |
| Albion VCT | 121.30 | 52.5 | 90.1 | 31-Dec-08 | -41.7% | 10.00 | 19.0% |
| Albion Techn & General VCT | 117.80 | 67.0 | 88.2 | 31-Mar-09 | -24.0% | 16.00 | 23.9% |
| Northern 2 VCT | 111.90 | 44.0 | 75.6 | 30-Apr-09 | -41.8% | 5.50 | 12.5% |
| Northern 3 VCT | 109.90 | 47.5 | 84.0 | 31-Mar-09 | -43.5% | 4.00 | 8.4% |
| Matrix Income & Growth 4 | 106.90 | 82.0 | 105.1 | 30-Apr-09 | -22.0% | 2.25 | 2.7% |
| Aberdeen Growth Opp I | 104.10 | 35.0 | 79.3 | 28-Feb-09 | -55.9% | 2.70 | 7.7% |
| Foresight 3 | 100.40 | 77.0 | 96.9 | 31-Dec-08 | -20.5% | 10.00 | 13.0% |
| Matrix Income & Growth 2 | 97.60 | 48.3 | 70.8 | 31-Jan-09 | -31.8% | 6.00 | 12.4% |
| Foresight 4 | 93.30 | 69.0 | 102.6 | 30-Nov-08 | -32.7% | 5.00 | 7.2% |
| Aberdeen Growth | 90.80 | 25.0 | 53.9 | 31-Jan-09 | -53.6% | 1.20 | 4.8% |
| Foresight VCT | 68.20 | 34.0 | 38.9 | 31-Mar-09 | -12.6% | 1.00 | 2.9% |
| Acuity VCT | 49.70 | 26.0 | 52.6 | 31-Mar-09 | -50.6% | 0.00 | 0.0% |
Source: NVM/AIC stats as of 4 June 2009.
By comparison, the FTSE has returned -1.1% over the past five years, not including dividends. If you add dividends, its total return would be, very roughly, 20%. Remember too the table above shows the best performers from the generalist VCT class, and that past performance is no guarantee of future returns.
Don't you love me, baby?
The table reveals a fly-in-the-ointment for VCTs -- the often huge discounts to NAVs of their share prices. These discounts mean VCT holders who want to sell their shares will have to give up as much as 55% of what they're theoretically worth.
Even before the current crunch, VCTs were illiquid, rarely traded investments languishing on big discounts and afflicted by 10% spreads.
Most people invest in VCTs for the initial income tax relief, which is granted provided the purchaser holds them for a certain number of years -- currently 30% if held for five years. Even a mediocre VCT can be positive if you take this tax relief into account. Buying through a discount broker makes new VCT issues pretty cheap to get into, too.
Purchasing in the secondhand market attracts no tax relief, however, and so that market is unsurprisingly sluggish. It's not helped by the fact that VCTs investors often plan to sell their holdings after their lock-in period ends, which depresses prices. Then there are the spreads making them expensive to deal in and out of.
During the recent market travails this discount in the secondhand VCTs has at times grown from big to extraordinary, due to various factors including:
- greater fear of risky investments in general;
- uncertainty about the accuracy of NAVs in a recession;
- guilt by association with the problems of mainstream, over-leveraged private equity;
- concerns that more of a VCT's holdings might go bust;
- question marks over yields should VCTs see fewer capital gains due to fewer company exits in the slowdown;
- the dire AIM market; and
- VCT market makers going out of business, widening spreads further (now improved)
Most of these concerns are very valid reasons for a widening discount -- and there will always be some discount to NAV even in the best of times, due to the uncertain value of unquoted investments.
But VCTs are also in a classic chicken-and-egg situation: their low volumes and big discounts deter buyers, which further reduces their price and so increases the typical discount.
It's all bad news for investors who want to sell. It's also an unhappy situation for VCT managers, who will struggle to attract our cash in the next round of VCT fundraising if these discounts persist.
Nobody wants to put money into an investment that they may need to sell at half what it's worth in a few years time.
This is first half of a two-part article. You can find part two here, in which Owain speaks with Tim Levett of NVM Private Equity.
> Disclosure: Owain has investments in a variety of VCTs, including some of those mentioned above.
