Investors putting their money into venture capital trusts (VCTs) will have to stomach more volatile returns as new rules mean they are pushed towards more risky investments.
In the Autumn Budget, chancellor Phillip Hammond announced changes to encourage investment into high-risk smaller companies and start-ups.
The income tax relief of 30% and the investment limit of £200,000 a year were not changed for investors. However, the amount a VCT can invest into a company was increased from £5 million to £10 million, with a requirement for more money to go to ‘knowledge-intensive’ companies.
What qualifies as knowledge-intensive will be determined by HM Revenue & Customs and is likely to centre on companies that spend a lot on research and development and have high levels of intellectual property.
Andrew Garside, manager of the Baronsmead VCT (BVT), said the rule change would mean a different approach to investing for many VCTs, which could be much riskier.
‘The rules mean VCTs having to change their investment approach and there will be greater volatility, but how much we do not know,’ he said.
While this could create more of a ‘boom and bust’ cycle he believed fund managers would find ways to mitigate this and smooth returns.
‘Investment managers will manage a portfolio to target a certain return – when they get those returns, it’s not by fluke,’ said Garside. ‘We encourage some companies [the fund invests in] to exit at a certain time so we can bank some returns. We’re confident we can get the same level of returns but with a bit more volatility.’
Garside added the new VCT rules also state that money must be invested more quickly and he said that will probably mean a change to the way funds raise money, with them ‘raising a bit less and using it and then raising a bit more later’.
While the popularity of VCTs has increased, with subscriptions more than doublng to £483 million in the last financial year, they remain a niche compared to the wider investment trust sector which raised £11.9 billion last year.
Trevor Hope, partner at Mobeus Equity Partners that manages the Mobeus Income & Growth VCT (MIX), said more growth capital would be required to support SMEs ‘as they navigate the uncertainties and opportunities which will be presented by Brexit’.
‘As investment strategies focus on earlier stage companies, VCT funds and their shareholders must expect a greater volatility in returns,’ he said.
Jo Oliver, manager of the Octopus Titan VCT (OTV), said investors had to be willing to put their money into high-risk investments if they wanted the tax breaks offered by VCTs.
‘We invest in early stage growth companies…UK-headquartered business that are looking to build a global business and generate 10x our initial investment,’ he said.
In order to mitigate that risk he makes small investments because ‘the reality is a number will fail’.
Oliver pointed to property portal Zoopla as one of his successful investments: ‘We invested when it had less than £100,000 of revenue and now it is a quoted company valued at $2 billion and we sold our shares last year at 33x initial investment.’
Oliver also noted Magic Pony Technology, which develops video compression software and was sold to Twitter for $150 million,
‘It had not generated a single penny in revenue and Twitter bought it,’ he said.
All investors are looking for the ‘Magic Pony’ companies that start small and are snapped up by a larger company, and Oliver said the closest he holds in his portfolio is Secret Escapes, a members-only travel club,
‘We invested when it was a travel plan…and in the next 12 months it will generate £1 billion of gross bookings.’
He added that there are ‘a number of business that think they can achieve a $1 billion valuation’ but he prefers companies that are ‘not going out looking for exits’ and that want to ‘build a big business and have exit opportunities come along’.