For venture capital trusts the last few years has seen a great deal of tinkering by those in power. However, it is fair to say many of the changes have been good for the industry and it means the outlook for VCTs for the next few years should be stable with very few further alterations expected.
The present Government seems committed to VCTs, which is clearly a good thing as studies show they impact positively on the economy. At a time when banks still seem to be struggling to lend to small businesses, VCTs are doing a good job of helping fill that gap.
One particularly positive rule change brought in from April 2012 was allowing VCTs to invest up to £5m in one company. At the same time the rules were tightened on the percentage invested in equity and loans in each transaction – basically more of each deal has to be in equity rather than loans now. However, increasing the limit to £5m does broaden the pool of potential companies considerably, making things easier for VCT managers to find decent investments.
An additional consequence is that VCTs no longer have any real size constraints. Larger deals used to have to be syndicated amongst various VCTs from the same manager but now there is no need. Rather than run multiple trusts, operating bigger VCTs is now better – certainly for investors.
The potential benefits include lower fees as the fixed costs are spread over a wider base, better diversification, and improved liquidity in the secondary market to name a few. I am sure the more enlightened VCT managers will look closely at seeking to merge their existing trusts into one “super-sized” VCT. I am also sure there will be a few howls of protest from directors as VCT boards get culled though.
There have of course been less favourable legislative changes impacting VCTs. However, perhaps the most significant one, CP12/19, seems to have receded. Readers may remember this was the rule that would have inadvertently classified VCTs as sophisticated products, thereby removing them from large parts of the market. Whilst I do not believe anything formal has been stated, perceived wisdom is that VCTs will not be caught by the rule.
My view is that VCTs are more complicated than, say, a straightforward equity income fund. However, they are publicly listed, have an independent board and regulated management. They also have a useful place in many investors’ portfolios – both small and large. CP12/19 was aimed rightly at sophisticated investments, and just like investment trusts VCTs should have an exemption.
Similarly, the RDR caused much consternation among VCT managers during 2012. Thankfully most worries seemed unfounded. There is still a degree of uncertainty about how advisers get paid fees, and some VCTs still seem to be paying commission, but calling it something else.
However, I think much of this is just early teething trouble rather than anything more fundamental. Hopefully a more homogenous approach will materialise this year as the variety of payment structures during 2012/13 fundraising season caused a lot of confusion amongst advisers and investors.
RDR 2 (or the recent platform paper) is also throwing up a few issues, mainly around execution-only brokers and whether commission will still be payable post-April 2014. Execution-only purchases of VCTs account for about half the market and if commission (and therefore discounting of commission) is banned it is likely this important source of funds will diminish.
Despite this issue investor demand remains strong for what is essentially a niche investment. The obvious tax benefits, notably tax free income, are firmly entrenched with investors. Amongst well-established, generalist VCTs dividend yields of 5 per cent are now commonplace with consistency an important factor. Whereas once dividends seemed a luxury from VCTs, now they are expected. It has become a virtuous circle as consistent dividend-paying managers are rewarded with new funds more readily than those with sporadic records.
It is no surprise then that the VCT industry appears in rude health. The 2012/13 tax year raised a reasonable sum of money, and there was resurgence in generalist VCTs after many years of limited life strategies dominating. Whilst some prefer limited life because of the defined exit route, I believe the investment credentials of the generalists are superior.
There is an abundance of quality now with managers such as Maven, Mobeus, Northern and YFM. Plus these are the VCTs policymakers are fond of. They provide much-needed capital to small business, the life-blood of our economy as well as providing investors with strong dividend flows. The future is therefore bright for the industry.
Ben Yearsley is the head of research at Charles Stanley