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Why 2014 could be the year to invest in Venture Capital Trusts

ON AVERAGE, investments through Venture Capital Trusts (VCTs) have returned 88.6 per cent over the last ten years (with dividends reinvested, assuming an annual 3.5 per cent fee), compared to around 65 per cent for the FTSE All–Share index. VCTs are not for everybody – they are designed to encourage indirect investment in a range of small, higher-risk trading companies whose shares are not listed on a stock exchange. But despite being volatile (see graph) and illiquid, over a third of financial advisers expect increased levels of interest in VCTs this year.

“Reductions to pension allowances have seen tens of thousands of savers cut off from making completely tax-efficient pension contributions, and VCTs are an obvious substitute,” says Rebecca O’Keefe of Interactive Investor. From April, the tax-free lifetime allowance on pension pots will be reduced from £1.5m to £1.25m, potentially dragging 30,000 savers into paying 55 per cent tax on their excess investments, according HMRC figures.

Re-allocating savings into VCTs is one way to minimise the impact of this change. Investments in VCT shares qualify for 30 per cent income tax relief for holdings kept for at least five years, providing no more than £200,000 is invested in VCTs per tax year. An investment of £20,000 would therefore have a net cost of just £14,000, while annual dividends and capital gains from the sale of shares are tax-free. But the five-year threshold, and the high-risk nature of VCTs, means they are suitable only for relatively sophisticated, long-term investors, says Jason Witcombe of Evolve Financial Planners. “There is a problem with liquidity, since VCT shares bought on the secondary markets do not qualify for tax relief.”

Richard Troue of Hargreaves Lansdown encourages investors to scrutinise the different types of VCTs. Some structure deals using loan stock as well as equity, with the loan repayments providing a regular income stream. “This can also make the deal less risky,” says Troue, “as the loans rank ahead of equity if the business fails.” He likes VCT manager Maven Capital for this reason. “With a higher proportion of loan stock, consistent dividend yields of 4 to 6 per cent are achievable,” he says.