What do the various VCT sectors offer investors?

 

Investors in venture capital trusts (VCTs) will find that there are many different types of VCT products on the market, according to Octopus Investments’ VCT business line manager Stuart Lewis. This means it is vital to understand what each type can offer.

The VCT structure means there are features that each will have in common, such as investing in smaller companies and offering attractive tax benefits. However, there are some important differences in the types of companies and industry sectors that they will invest in.

In the following article, Octopus Investments – the largest VCT provider in the UK^[1] – explains that there are three main kinds of VCTs and offers some insight into what they could bring to an investor’s portfolio.

Generalist VCTs

The largest segment of the VCT universe is ‘generalist’ VCTs, which account for around 75 per cent of the market. VCTs that fall into this bracket invest in a broad range of promising, entrepreneurial businesses operating in a variety of sectors and so can create diverse portfolios of investments. Many of these businesses will be unquoted – meaning they are not listed on any stock exchange.

“The vast majority of VCTs fall into what the industry classes as generalist VCTs,” Lewis said. “This bucket is very wide, and within it there are huge differences in investment objectives, ranging from those investing into early-stage companies with the potential for high-growth, to those who have historically focused on management buyouts.”

The wide range of investment objectives found in the generalist sector means that, as when researching most other types of investments, investors need to understand exactly what the VCT will be investing in, the risks posed, and the end goal it is pursuing.

Octopus Titan VCT, the largest VCT in the UK^[2], with assets under management of more than £260m, resides in the generalist sector. The portfolio comprises around 50 companies spread across a range of industries, with a bias towards technology-enabled companies. It aims to generate capital growth for its investors, paying this out as regular and special dividends when portfolio companies are sold at a profit.

Data from FE Analytics suggests the fund has been successful, as it posted a 110.68 per cent total return over the five years to the end of 2015, while the average VCT in the generalist sector, on the other hand, made 31.44 per cent. It must be kept in mind, however, that these investments can go down in value as well as up, and past performance is no guide to future returns.

Octopus Titan VCT cumulative performance

Source: FE Analytics, bid-to-bid total return in sterling with dividends reinvested over five years to 31 Dec 2015

Octopus Titan VCT discrete performance shown to the VCT’s year-end accounting period

Source: Octopus Investments. The annual total return is calculated from the movement in NAV over the year to 31 October, with any dividends paid over that year then added back. The revised figure is divided by the NAV at the start of that year to get to the annual total return. Performance shown is net of all fees and costs. Past performance is not a reliable indicator of future results and may not be repeated.

Octopus Titan VCT has engaged with a range of successful companies, including household names that the fund backed from an early stage including Zoopla, Graze, Secret Escapes and SwiftKey – which recently created headlines after Microsoft bought the company in February.

While the early-stage, high-growth focused Octopus Titan VCT provides an example of a fund looking for growth, another Octopus Venture Capital Trust shows how varied the offerings in the generalist sector can be.

Octopus Apollo VCT invests in more established companies rather than start-ups, and while never guaranteed, it aims to provide regular tax-free dividend income to investors, with a greater focus on capital preservation. In order to do this, it invests in around 25 companies – the majority of which have already proven to be profitable.

This VCT also takes advantage of rules that allow it to invest in the debt as well as the equity of these companies. The aim of this is to create more predictable returns for investors as debt investments have a more reliable payment stream than equity investments in terms of the pre-agreed interest payments.

Our data shows that over the five years to the end of 2015, the Octopus Apollo VCT made a 31.53 per cent total return and offered its investors a smoother ride than Octopus Titan VCT: Apollo’s yearly volatility was the sixth lowest in the Association of Investment Companies’ VCT Generalist sector at 6.51 per cent, while Titan’s stood at 14.24 per cent. Investors should remember that all VCTs are classed as high risk investments, and investors may not get back the full amount they invest. Past performance is also not a reliable indicator of future returns.

Octopus Apollo VCT discrete performance

Source: Octopus Investments. The annual total return for the Octopus Apollo VCT is calculated from the movement in NAV over the year to 31 January, the latest available data, with any dividends paid over that year then added back. The revised figure is divided by the NAV at the start of that year to get to the annual total return. Performance shown is net of all fees and costs. Past performance is not a reliable indicator of future results and may not be repeated.

AIM VCTs

Although generalist is the most common type of VCT, it is not the only one. Another notable type are VCTs that focus on investing in companies listed on the Alternative Investment Market (AIM), which was launched around the same time as VCTs as part of government efforts to channel investment into the UK’s smaller companies.

Lewis said: “AIM VCTs are pretty self-explanatory – they focus on companies listed on AIM. This can give people comfort in the transparency of their investments, as they can see the daily market price of the underlying holdings and there are minimum levels of regulation required to list on the market.”

AIM is a sub-market of the London Stock Exchange and allows smaller companies to offer shares under a more flexible regulatory regime than applies to the main market.

Over 1,000 businesses are currently listed on AIM; by listing here, they are not considered ‘start-up’ companies anymore, although most will still be small and have a higher level of risk than companies listed on main market of the London Stock Exchange.

Octopus Investments has two VCTs that focus on AIM, both of which have good long term track records having been established in 1997/1998 and 2005, respectively. FE Analytics shows that both of these portfolios have outperformed their average peers over the five years to the end of 2015, although investors are reminded that past performance is not a reliable indicator of future returns.

Octopus AIM VCTs cumulative performance

Source: FE Analytics, bid-to-bid total return in sterling with dividends reinvested over five years to 31 Dec 2015.

Octopus AIM VCTs discrete performance

Source Octopus Investments. The annual total return for the Octopus AIM VCTs is calculated from the movement in NAV over the year to 31 January, the latest available data, with any dividends paid over that year then added back. The revised figure is divided by the NAV at the start of that year to get to the annual total return. Performance shown is net of all fees and costs. Past performance is not a reliable indicator of future results and may not be repeated.

Investing in AIM means that some of the VCTs’ holdings may be more familiar names to the end investor. Investments that have been held by Octopus AIM VCT and Octopus AIM VCT 2, for example, include wealth management company Brooks Macdonald, recruitment firm Staffline Group and motor retailer Vertu Motors.

Specialist VCTs

While the above types of VCTs have a remit to invest in a broad spectrum of companies, there are other VCTs that have much more focused objectives.

“Specialist VCTs are, as the name implies, focused on a specific sector or market,” Lewis said.

Within the Association of Investment Companies (AIC) universe, the industry body for investment trusts and VCTs, there are four specialist sectors offering focused exposure to innovative areas of the market. These include environmental VCTs, infrastructure VCTs, media, leisure and events VCTs and technology VCTs.

The attraction of these VCTs is that they offer the investor a chance to invest in a particular part of the market. For example, if an investor believes that the move towards societal infrastructure is a trend that will only get stronger, they can buy a portfolio of companies which are poised to benefit from this.

However, as Lewis points out, this approach is not without its risks: “Specialist VCTs have the potential to outperform if that sector does particularly well, but they also have a higher concentration and market risk, as they are more exposed to a single sector outcome. They are often smaller in size, due to the sector restrictions on available investments, and so can have higher percentage of fixed costs relative to the size of the fund.”

The above article was prepared in partnership with Octopus Investments and should not be taken as investment advice.

Important Information:

We always recommend investors seek professional advice before deciding to invest. Personal opinions may change and should not be seen as advice or recommendation. Tax treatment depends on individual circumstances and may change in the future. Tax reliefs depend on the portfolio companies maintaining their qualifying status. The shares of smaller companies and VCT shares could fall or rise in value more than larger companies. They may also be harder to sell. This advertisement is not a prospectus. Investors should only subscribe for shares based on information in the prospectus, which can be obtained from octopusinvestments.com. Issued by Octopus Investments Limited, which is authorised and regulated by the Financial Conduct Authority. Registered office: 33 Holborn, London EC1N 2HT. Registered in England and Wales No. 03942880. Issued: February 2016.

[1] Source: Tax Efficient Review, 2015

[2] Source: Association of Investment Companies, January 2016