What do Zoopla, Secret Escapes and Virgin Wines have in common? They are all beneficiaries of the venture capital trust scheme launched 30 years ago.
VCTs invest in early-stage, often unlisted companies and, today, mainly provide exposure to sectors such as fintech, life sciences and AI. As such, they can be very high risk.
To compensate, they offer retail investors a pretty striking upside — one that, as capital gains tax rates rise, Isa allowances are frozen and pensions are brought under the scope of IHT, is becoming increasingly rare in the UK: they can be incredibly tax efficient.
Investors receive 30 per cent income tax relief (if held for five years) on a generous annual allowance of £200,000; tax-free dividends; and no tax to pay on profits.
So why are the numbers of people using VCTs still relatively low? With only about 25,000 people using the scheme, one analyst dismisses them as “a minority pursuit”.
The big problem for VCTs is dull performance. Tighter rules from 2018 mean the focus has to be on earlier-stage companies rather than later-stage management buyout opportunities. In theory, this gives the potential for higher returns if the managers get it right.
But over the past five years, the average share price total return for the VCT sector is just 7.7 per cent vs 51 per cent from the average investment trust, according to data from the Association of Investment Companies; over the past three years it’s a 16.1 per cent loss, vs 16.6 per cent gain from investment trusts.
Underlying the VCT average is a massive range of outcomes — over five years the extremes in performance were from 73 per cent growth to an 84 per cent loss.
“VCT performance has been tough in recent years,” says Jason Hollands, managing director at Evelyn Partners. “Many earlier-stage companies’ growth plans were hard hit by the pandemic, stalling growth assumptions made at the time they were originally backed. The Aim market, where some VCTs invest, has also been through a pretty torrid period too.”
A survey by Wealth Club, a broker of tax-efficient and alternative investments, found that 43 per cent of VCT assets are invested in companies increasing revenues by 25 per cent a year or more. Yet, VCT managers often target returns of 5 per cent a year after charges, which doesn’t seem so ambitious, when you can still receive that in a “risk free” savings account.
“Over the long term these should be delivering 10 per cent per annum yet they don’t through a combination of high charges and the industry raising too much money,” says Ben Yearsley, director of Fairview Investing. “Despite the tax breaks investors could easily get bored if they only deliver 5 per cent per annum returns.”
The performance problem is compounded by continuing high fees across the sector. After all, compounding fees has a higher effect when you’re losing money.
The justification is that, because these trusts invest in small companies in technical sectors, they need big teams of expensive staff with PhDs and medical qualifications. They also need to maintain good compliance and governance in order not to lose VCT qualifying status.
Although some trusts have introduced tiered fees that reduce when assets reach a certain threshold and others have reduced fees on cash balances, analysts say progress on fee reduction feels disappointing relative to the downward cost pressures on other types of investments. “With VCTs generally much larger in size than a decade ago, you would have thought charges would have come down but they’re broadly the same,” says Yearsley.
Plus, the fees are often opaque — you’ll have to trawl through the 50-page prospectus to find them. While you’ll also need to watch out for exit fees too.
Nimesh Shah, chief executive of Blick Rothenberg, an accountancy firm, has some words of caution. “You might do well to break even. You need to have eyes wide open on how much you feasibly lose.” He suggests putting the equivalent of the 30 per cent upfront relief into an investment that will bring you 3 per cent conservatively. Then calculate how much you can lose on the VCT before you’re out of pocket.
Despite these issues, Wealth Club, an investment service, reports that total VCT fundraising for 2024/25 is 10 per cent ahead of where it was at the same point last tax year. Wealth Club investment manager Nick Hyett says: “It’s difficult to be certain about what’s driving that increase, but we think frozen tax thresholds and investment allowances are playing a significant role.”
Certainly, 30 per cent income tax relief, and particularly tax-free dividends, become increasingly attractive as more workers are pushed into higher tax brackets by inflation. The decision to freeze individual savings accounts (Isa) allowances since 2017 has resulted in a real terms cut of about 25 per cent — meaning more people will maximise their allowance every year.
VCTs have also been intrinsically tied to pensions tax relief for the past 10 to 15 years. Yearsley says: “Annual allowances, tapered annual allowances, lifetime allowances — they’ve all had their impact on VCT fundraising.”
Younger earners (perhaps those investing their bonuses) may be mindful that their pension money is locked away until at least 57, while a VCT only has to be held for five years. Octopus, a provider of VCTs, claims the age of a VCT investor is trending younger. In the 2018/19 tax year, the average investor was 63. By 2023/24, that had fallen to 54.
Pension tax reliefs are provided at the subscribers’ marginal income tax rate — up to 45 per cent — whereas VCT income tax credits are provided at 30 per cent. This makes VCTs an adjunct to a pension rather than a replacement.
But the very highest earners are severely restricted in what they can contribute to pensions, leaving the VCT allowance as one of the few tax- efficient investment options still available. Most people have a pension annual allowance of £60,000. But the annual allowance is reduced by £1 for every £2 someone earns over £260,000 (including pension contributions). Tapering stops when the annual allowance reaches £10,000.
Some also think VCTs could benefit indirectly from the move to include unused pension assets into estates for IHT purposes from 2027. While VCTs don’t in themselves have any inheritance tax benefits, Hollands says: “We may see some investors drawdown on pensions that they had intended to leave untouched and instead recycle this money into VCTs.”
If you’re planning to do this, consider that pensions invested in the right funds, trusts or shares have the potential to deliver superior returns. So, take investment advice and be prepared to lose your money.
Moira O’Neill is a freelance money and investment writer. Email: moira.o’neill@ft.com, X: @MoiraONeill, Instagram @MoiraOnMoney
