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End of year musings – VCTs

Should I continue to invest in VCTs, I ask myself. Hold, Buy or Sell?

I was steered into these investments by my financial adviser, when I was busy working and never had the time to get to understand what I had bought until I retired.

So, to start my decision process, I looked at returns. Northern VCT total returns are 3.6% gross (5.1% after 30% tax relief)  p.a. compound since 1995, 24 years ago when I invested. Baronsmead 3 total returns are 3.6% gross (5.9% after 30% tax relief) p.a. compound since 1998, 21 years ago when I invested. Not great but not a disaster.

The AIC website enabled me to quickly review the returns over the past 10 years, of those companies where I hold shares. These figures are gross and annualised over the ten year period. The Kings Arms performance may look good in this table, but it was awful in the previous 10 years.

5 factors indicate future returns will not be as good as historically:

  1. Many asset based investments are no longer qualifying investments. These were reasonably safe, e.g. solar and wind farms. VCTs now have to be invested in higher risk companies.
  2. There is more money going into VCTs. More supply of capital will, all other things being equal, drive down returns.
  3. Pension tax relief is now severely limited. VCTs are one of the few remaining ways to reduce your tax bill, for those looking for ways to do so. Financial advisers are steering their clients into VCTs.
  4. Fees paid to investment managers remain high. In my opinion far too high.
  5. Corporate governance in many VCTs is poor. Too many directors are too closely aligned with fund managers and lack independence and a willingness to confront their investment managers. This is the main reason point 4 will persist.

These last two points have been explained further in https://www.sharesoc.org/campaigns/vct-investors-group/

My decision? I am still enjoying a healthy tax free income from these VCTs, so I won’t sell them. But I won’t invest any more in this year’s new offers.

I have however now decided to invest in the fund managers who manage VCTs, rather than the VCTs themselves. Despite my personal concerns about investing in VCTs, I think the current trends of increasingly large fund raisings and high fees for managers will continue leading to increases profits and share prices in these fund managers. I have just bought shares in Mercia, who are the new manager of the Northern VCTs. (see https://www.sharesoc.org/blog/vcts/northern-vcts-and-mercia/ for more info). I bought shares in Gresham House Strategic in June 2017 @911p and March 2018 @828p. Gresham manage Baronsmead VCTs and are now trading at 1275p, so a healthy gain so far.

Disclaimer: I own shares in all the above companies. I am not qualified to give advice and do not take any of the above as advice or a recommendation.

Cliff Weight, Director, ShareSoc

12 Comments
  1. rogerwlawson 3rd January 2020 at 10:54 am

    A very good analysis Cliff of VCTs, although you have missed the word “no” out of “no longer qualifying”. I think it’s a bit early to judge whether the new VCT investment rules will reduce returns. Picking “safe” VCTs with high asset backing in the past was not necessarily a recipe for success. But likewise those inexperienced managers who backed start-ups were also a recipe for failure.

    • Mark Bentley 5th January 2020 at 8:50 pm

      Thanks Roger, I have updated the post to correct the typo you pointed out.

  2. Mike Dennis 3rd January 2020 at 4:18 pm

    Thanks Cliff – very good analysis. How ironic that you now feel obliged to invest in the VCT managers rather than the VCTs because you expect them to generate a better return than the funds they manage.

  3. Julian Strickland 3rd January 2020 at 6:50 pm

    An interesting idea investing in the managers rather than their funds. After all we have an idea who owns the yachts.

  4. David 4th January 2020 at 6:48 pm

    This seems to understate the effective benefit from VCTs. They tend currently to target 5% divs on NAV, so yielding 7% after the upfront tax relief, but this has to be compared with pre-tax returns on other investments, since the VCT divs are tax free. If you suffer tax on divs at 32.5%, you need a 10% pre-tax yield to compensate. So the tax advantage of a VCT is enormous and more than compensates for the high management fees and carry.

    Furthermore, the upfront relief is effectively renewable. So if you have been investing in VCTs each year, you can sell 5 year old VCTs and reinvest in the current year, so effectively renewing the tax relief without increasing overall exposure. The anti avoidance provisions here are very, very weak in that relief is denied only if you have invested and sold shares in the one specific VCT in a 6 month period. So if you have a bunch of VCTs you should churn them every 5 years and renew the upfront tax relief. Having moved from active employment into semi-retirement, I don’t expect EVER to pay income tax again by utilising this churning process on my substantial VCT portfolio.

    This of course relies on there being plenty of issuance going forward (currently OK) and the anti avoidance rules not changing (not a high priority in my view). It’s a bit of a fag to do the churn and select new issues and so forth (and of course the sale of VCTs involves selling to the VCT itself with a 5% discount), but this wizard wheeze has significant benefits in terms of renewing tax relief each year.

  5. barry collins 5th January 2020 at 11:13 am

    A most thought provoking piece, I share a lot of your sentiments but I think you are holding the only 2 managers in which there is a quoted share, which makes it a rather small pool to fish in ?
    Sadly Mercia is a company which only last month cut their small shareholders out of a placing at about 40% discount (in order to buy NVM), so that doesn’t fill me with enthusiasm, neither did their long term Chair, the (then highly rated) but very overboarded S Searle whom they shared with, amongst other companies, WPCT, and even when Woodford’s issues/problems were well known it took a long time before she resigned. I note that the board have since apologised for cutting the small shareholders out, but to paraphrase Mandy Rice Davies, “they would, wouldn’t they” ?
    Thus the time it took to change their Chair & their treatment of loyal shareholders does raise questions in my mind. Just as one should never make an investment purely on tax reasons perhaps the lack of quoted VCT managers makes it difficult to invest in the best ?
    On the other hand, with Albion partners awarding themselves 67% pay increase for last year I can not fault your fundamentals, certainly if Amati/Albion/Maven to name but 3, were quoted I would definitely be copying you !

    • David 5th January 2020 at 12:14 pm

      Mercia screwed their small shareholders by doing a large ABB at a 21% discount to the prevailing share price and a 40% discount to NAV. Shocking. Not even an Open Offer component. One thing which ShareSoc might do is to promote The PRimaryBid type of platform for involving retail – even in quick fire ABB situations. See the recent Futura Medical offer.

      While I don’t like Mercia as a long term investment, I’ve often found a decent trading play in big discount placings is to buy immediately afterwards (if one can’t get in on the placing) with a view to a say quick 10% gain as the market normalises. I’m afraid this does nothing for those shareholders who have been bashed by the dilution, but they can also play this game to maintain their stake, rather than just stay bashed.

  6. David 5th January 2020 at 11:39 am

    In venture capital (unlike listed investments), there is “persistence of returns” so that upper quartile managers bag most of the returns and everyone else has mediocre returns. Mercia is dominated by its own balance sheet investments which are fairly ordinary and not upper quartile. If you want to back UK or European venture, then a diversified play with plenty of potential for outperformance, Draper Esprit wd be a far better choice than Mercia. DE also has a small VCT angle but it’s return are dominated by upper quartile investments.

  7. cliffw8 5th January 2020 at 4:53 pm

    Mercia traded at 24p, ie below the 25p placing price after the placing, so in this case David and others could have got an even better deal than those who participated in the placing: and without the risk taken by those who participated in the placing. (It is too late now as they have risen to 27p.)
    Notwithsthanding this, I accept your more general point that retail shareholders should not be disadvantaged in placings. Ways need to be found for them to participate.
    I would like to see, say 10% of the placing reserved for retail shareholders, to be clawed back from those big investors who agree to participate in the placing, on the basis that if they (retail investors) don’t take it up the big investors subscribe instead. There is a problem of making too many people insiders which precludes (so I am told) a more general offer to retail investors.
    The LSE are concerned about this issue of how to involve retail investors and how to ensure they are treated fairly and ShareSoc are going to meet them to discuss this further.
    Primary Bid is an interesting concept. Peter Parry and I are meeting them on Tuesday 7 Jan to discuss how we might work together to improve the way things currently work.
    Thank you all for your comments, positive or negative. Please keep them coming.

  8. David 5th January 2020 at 5:28 pm

    I recommend PrimaryBid as a vehicle for retail participation. They have done a lot of fairly low end issues but more recently 2 decent issues, Duke Royalty and Futura Medical, where they raised a reasonable amount. I played in both. They have some deal with the London Stock Exchange now. Very cost effective, good custodian/receiving agent in Jarvis and settlement is direct to yr broker’s Crest account. The only problem is the limitation on subscription amount placed on yr debit card and you often have to move very quickly, like over a weekend (not a problem for me).

  9. David 5th January 2020 at 5:41 pm

    Incidentally, I participate in a good few placings having been made an insider under the Market Abuse Regs having given the issuing broker the appropriate MAR undertakings. Brokers only want to deal with their Pre-existing clients both for economic, credit risk and avoidance of leak reasons. They also (generally) only want to deal with investors on an “elective professional client” basis, which is generally not suitable for most small retail investors. No such restriction applies to PrimaryBid who are therefore able to deal with anyone able to deliver them cash against order, arguably a real democratisation of the issuing process.

  10. David 5th January 2020 at 9:10 pm

    Incidentally, incidentally, I’m aware that PRimaryBid pay a commission to introducers who promote the platform. So if you end up liking it, you can feature an account opening link on the ShareSoc site and you will get a share of PB commission on applications for issues in accounts introduced, which wd help finance yr activities.

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