For high earners who have already maxed out their ISAs and pension contributions, venture capital trusts (VCTs) are often the next logical step in their savings journey.
VCTs offer 30% tax relief upfront and tax-free dividends, according to Nicholas Hyett, investment manager at Wealth Club.
Although the maximum annual investment is £200,000, most investors commit a far smaller amount to VCTs and endeavour to build up a diversified portfolio over several years.
“General advice is not to put more than 10% of your net worth into tax efficient investments. That assumes you've already built up a sizable pension pot and sizable ISAs,” he said.
The average amount that Wealth Club clients invested into VCTs in the 2023/24 tax year was £35,600 and the average commitment to an individual VCT (most of which have minimum investments of £3,000) was £10,651.
For an investor who has maxed out their ISA and pension and still has, say, £50,000 to put to work before the end of the current tax year, Hyett suggested allocating 30% apiece to Baronsmead, Octopus Apollo and Pembroke VCTs, supplemented by 10% in Fuel Ventures VCT. All of these funds had capacity at the time of writing.
Hyett described the Baronsmead VCTs, which are managed by Gresham House, as “a great entry gateway to VCTs”.
“The Baronsmead portfolio is probably the most diverse of all VCTs. The two VCTs have a portfolio of 85 companies spread across early-stage growth businesses, legacy management buyouts and AIM, as well as investing in three Gresham House managed UK equity funds,” he explained.
“What they give you is a lot of less-racy, established businesses, but they also give you access to a historically very strong-performing private investment team.”
AIM stocks and UK small-caps have been out of favour in recent years but if the market turns, Baronsmead could enjoy an upswing. “With 65% of the portfolio invested in UK-listed companies, a turn in sentiment towards the UK has the potential to translate quickly into substantial gains for the VCT.”
Hyett suggested supplementing Baronsmead with three sector specialists, Pembroke, Octopus Apollo and Fuel Ventures.
Pembroke invests in high-end consumer businesses such as fashion brand ME+EM, burger chain Five Guys and fresh pasta delivery service Pasta Evangelists.
Its portfolio is quite concentrated with 15% in its largest investment LYMA, the anti-ageing skincare company, which has developed a medical-grade laser for use at home. “It was voted one of TIME Magazine’s inventions of the year in 2023 and the VCT’s investment is currently valued at 16.9x cost,” he said.
Octopus Apollo, meanwhile, specialises in business-to-business (B2B) software providers, which are capital light, high-margin businesses, Hyett said. Octopus Apollo often funds the rollout of a product to a larger client base and, because very little is required in the way of capital expenditure, additional sales drop through to the bottom line quickly.
There is also an obvious route to exit. “Private equity companies love these kinds of businesses because they can buy and bolt them into an existing platform,” he observed.
“Backing more mature businesses in high margin, cash generative software might be seen as boring, since it generally doesn’t have the same potential for explosive growth you see in VCTs that back smaller, higher growth companies.
“However, its high-quality investments have helped it weather the recent downturn in venture capital better than many peers – with a total return of 49% over the five years to December 2024 (not including tax relief).”
Hyett’s third pick, Fuel Ventures VCT, launched last year and has already raised more than £10m, making it one of the most successful VCT launches ever, he said.
“It takes time for VCTs to build a portfolio and deliver the exits that underpin dividends. As a result, the Fuel VCT is currently very concentrated, with just nine companies in the portfolio, and doesn’t plan to pay dividends until 2027 at the earliest.
“However, in backing the Fuel VCT early, investors benefit from the manager’s investment expertise and Fuel has a good track record here. Its EIS [Enterprise Investment Scheme] funds are some of the best performing in the market and focus exclusively on early-stage marketplaces, platforms and SaaS [software as a service] businesses. The VCT is expected to back the most promising of those EIS investments.”
Specialist VCT managers possess deep expertise and market knowledge and get access to the best deals because entrepreneurs know them and are more likely to approach them for funding.
The drawback for investors who can only afford to select one or two VCTs is that sector specialists are highly exposed to their sectors and vintages.
“You get years where almost everybody picks winners and years where almost everybody picks losers because when the market gets really hot, everything's over-valued and it is very difficult to make money. When everybody's running away from the market, everything's really cheap. It's easy to make money.”
For this reason, investors would be wise to build up a portfolio of VCTs over a number of years or use diversified, generalist VCTs such as Baronsmead.
Someone with £100,000 to invest this year could afford to include EIS, which have a £25,000 minimum per fund. In this scenario, Hyett would choose Parkwalk Knowledge Intensive EIS for 25% of the portfolio and would then split the remainder equally between Baronsmead, Octopus Apollo and Pembroke.
Parkwalk backs spin-outs from the UK’s universities and research institutes. The companies in which it invests can take years to mature, so the payback is likely to be slower than other EIS funds, he pointed out.
“Past successes include Lumenisity, a developer of improved fibreoptic cabling from the University of Southampton, which was acquired by Microsoft, and Oxford University spinout YASA Motors, which develops electric motors, which was sold to Mercedes-Benz,” he said.
“Although only suitable for a small portion of an investment portfolio, these investments are hard to access elsewhere.”