Pros & cons of VCTs

[TimR]

Just received a letter to invest in Unicorn VCT from my platform (Best Invest)

As a 63 year old who has just retired on a pension income plus a SIPP and ISA containing shares.- What are the Pros & cons of VCTs like this?

TimR

[UncleEbenezer]

Pros and cons compared to what? A self-managed portfolio of UK micro-caps with or without (S)EIS? A non-VCT managed fund with similar investment mandate? Generic managed or tracker funds? Non-VCT PE? Big caps? Other forms of tax shelter? Cash?

Unicorn is somewhat untypical of VCTs. It behaves like something of a halfway house between typical VCT and generic high-yield microcap fund. Pros include tax breaks, cons include restrictive VCT rules.

[scotia]

Like all investments, it is difficult to predict forward performance, and this is especially so in VCTs since the investment rules have been substantially revised in recent years.
However I started into VCTs at around your age a decade ago, as part of a diversification plan, and I'm still investing in them, albeit recycling older ones to continue receiving the tax break, and keeping my total VCT investments below 10% of my overall savings.
VCTs provide a collective investment in small start-up companies. As may be expected, many such companies fail, while others prosper - hence my need to use a collective investment.
Remembering my proviso that it is difficult to predict the future, I have been happy with past performance. The VCTs have provided a steady stream of income - similar to an annuity, but with the added advantage that the income is tax free, and the capital remains (or has increased) when the initial tax break of 30% on the cost is taken into account.
Now onto specifics - as Uncle stated, Unicorn AIM VCT is somewhat unusual. Its NAV performance has been good, but its discount to NAV when selling at the end of a 5-year hold is substantially larger than many other VCTs. It is also not very generous in its dividends.
The two most popular long-term VCT managers are probably Baronsmead and Northern. Last year they only issued a small quantity of new shares - and many applicants (including myself) were disappointed. This year they are raising substantially more funds - but I suspect they will have little difficulty in selling them.
For the record, myself and my wife have modest investments with Managers Baronsmead, Northern, Mobeus, Proven, Octopus, British Smaller Cos, Maven, Elderstreet, Chrysalis, Amati, Artemis , Unicorn , Pembroke. Again - with diversification, hopefully comes stability.

[BusyBumbleBee]

Just received a letter to invest in Unicorn VCT from my platform (Best Invest)
As a 63 year old who has just retired on a pension income plus a SIPP and ISA containing shares.- What are the Pros & cons of VCTs like this?
TimR

Good morning, Tim.

Unicorn started the year at about 140 and at the moment is trading (mid) at 141.5 (less than 1% increase). This in a year that the AIM index went from 825 to 1021 (23% increase). Historically - over five years it has gone from low 90's to 141.5 (56% increase). while the AIM index went from 700 or 1021 (45% increase). So draw your own conclusions on this.

My take on this is that while the Unicorn manager' has the pick of qualifying new AIM shares it has certainly not done particularly well in the past 12 months - a very benign 12 months for AIM- but had done well in the past. You have to take your view on the future but must bear in mind that that there could be a big fall in AIM stocks and that the choice of new investments in AIM stocks is more limited than in the past.

Contrast Unicorn with AMATI which has seen all of its 35% rise over 5 years actually occur in the past 12 months.

And then ask which is better prepared for the future.

I confess I do not hold Unicorn but I have a small investment in AMATI - which has done me well so far cos I have captured all of the 5 year gain in about 2 years together with reasonable dividends.

Would I buy any more AIM VCT shares? No. Why?

I am not going to buy any more new VCT shares except a few DRIS shares because

a) I shall lose roughly 2% per year in charges while the money sits with the manager waiting to be invested.
b) I have no confidence that the managers can cope with the new rules
c) I (as you know) am a natural contrarian and when VCTs are being pumped as much as they are at the moment and new PIs are looking to invest and they are talking of record sums being raised then I will go the other way
d) the AIM index is very high and waiting for a big fall.
e) the downside is greater than the upside
f) the Patient Capital consultation could produce some nasties

So I shall sit back and wait for the lemons to fall off the investment tree, investors to become very disillusioned and dump their shares and then buy at distressed prices (I hope!) as I have done in the past.

If you do buy then you can look forward to a 30% tax break - but you are locked in for five years and if the shares fall more than that you can only sell at a loss and the much vaunted capital gains exemption means that you cannot offset your losses. Dividends are being cut all over the place so these are unlikely to help much during the lemon ripening season.

My guess is that over the twenty year life of VCTs there have been more VCT losers than winners - and the winners haven't been that great anyway. Certainly Unilever - a very boring company - has done rather better than the vast majority of VCTs - doubling in the past 7 years with a rising dividend.

with kind regards - BBB

[UncleEbenezer]

Just received a letter to invest in Unicorn VCT from my platform (Best Invest)
As a 63 year old who has just retired on a pension income plus a SIPP and ISA containing shares.- What are the Pros & cons of VCTs like this?
TimR

Good morning, Tim.

Unicorn started the year at about 140 and at the moment is trading (mid) at 141.5 (less than 1% increase). This in a year that the AIM index went from 825 to 1021 (23% increase). Historically - over five years it has gone from low 90's to 141.5 (56% increase). while the AIM index went from 700 or 1021 (45% increase). So draw your own conclusions on this.

My take on this is that while the Unicorn manager' has the pick of qualifying new AIM shares it has certainly not done particularly well in the past 12 months - a very benign 12 months for AIM- but had done well in the past. You have to take your view on the future but must bear in mind that that there could be a big fall in AIM stocks and that the choice of new investments in AIM stocks is more limited than in the past.

Contrast Unicorn with AMATI which has seen all of its 35% rise over 5 years actually occur in the past 12 months.

The AIM index is not really a good proxy, because a lot of AIM is not open to VCTs. I expect that, for example, the last year's AIM performance is much affected by a wider sharp upturn in resource stocks that are out-of-bounds for VCTs. And of course, VCTs need the flow of IPOs and other fundraising events to make their qualifying investments.

The sudden reversal of Amati's fortunes after a long period as laggard kind-of demonstrates that even within AIM VCTs, not all are equal.

FWIW, I hold both Unicorn and Amati. Unicorn is one of my biggest VCT holdings; Amati more modest.

My guess is that over the twenty year life of VCTs there have been more VCT losers than winners - and the winners haven't been that great anyway. Certainly Unilever - a very boring company - has done rather better than the vast majority of VCTs - doubling in the past 7 years with a rising dividend.

with kind regards - BBB

That's been a learning process: bad VCTs have failed, lost lots of money, been taken over. Consolidation and survivorship bias has left us with a more mature industry. We've just been through something of a golden age, starting in about 2013 (when my VCT income first fully covered the rent, having more than doubled from the previous year). The future is more uncertain under new rules.

As for Unilever, it's easy to pick winners in retrospect. 7 years ago most commentators on investment would've talked of Tesco in the same terms.

[BusyBumbleBee]

The sudden reversal of Amati's fortunes after a long period as laggard kind-of demonstrates that even within AIM VCTs, not all are equal.

- agreed - just my point. Roughly speaking AMATI went up with the index this past year.

We've just been through something of a golden age,

So true - seven fat years as it were. 7 lean years to come?

The future is more uncertain under new rules.

so true and the likely impact should not be under estimated.

As for Unilever, it's easy to pick winners in retrospect. 7 years ago most commentators on investment would've talked of Tesco in the same terms.

I didn't but a kind ancestor did: leaving holdings in Unilever, Shell and what is now HSBC. All of which have done very well and would have paid for my house - yet alone the rent, if I hadn't already bought it with money I earned overseas.

Tesco and M&S were the 'darling retailers at the turn of the millennium. Both saw turnover and profits rise rapidly and both maintained the rise in 'profitability' when turnover growth more or less stopped. Any cursory look at the accounts showed this and it was obviously unsustainable. Because my business was largely with large retailers I did examine their accounts with rather more care than the average investor and steered well clear of them. Only one (Sainsbury's) would I consider because it is a Yo-yo share.

VCTs are opaque, expensive - in terms of fees etc , illiquid with large spreads and rarely deliver what they say they will. The OP actually knows this, having been bitten with previous VCT investments. The only really good VCT investments I have made are those where I only paid 40 pence per share for (rollover of CGT and income Tax Rebate of 20%) and those bought second hand at distressed prices where the original investors (or their heirs) probably got less than 30 pence per share.

[Kidman]

What are the Pros & cons of VCTs like this?

Tim,
I could take "like this" in various ways, AIM VCTs, VCTs that are being pushed by a broker, or just VCTs in general. May I make a few general points on the basis of VCTs in general.
Pros,
an opportunity to invest in a collective vehicle which invests in start-up companies with the potential for high growth;
a tax-free dividend stream if all goes to plan;
a possibility of making a tax-free capital gain after the tax relief hold period of five years.
Cons,
shareholders are locked in for five years on account of the initial tax-relief;
the shares are fairly illiquid at any time;
they can only be sold at a discount to NAV and in some cases this can be very significant especially when one takes into account dealing costs and spread;
high management fees without a commensurate performance;
performance fees that are usually loaded in favour of the management company rather than the shareholder;
as many shareholders hold their VCTs for many years the initial tax relief becomes a small percentage per annum.

I totally agree with BBB about Unilever. Indeed many mainstream investments regularly outperform VCTs even after all tax has been paid. Hence, max out your ISA first and then if you want a dabble try a VCT but DYOR. I further agree with BBB that we shouldn't expect VCTs to return as well as hitherto now they can't do MBOs for example and when the taxi-driver is telling you to buy them it's way too late!

I keep buying a few as I have invested in VCTs since they started but I put more money into alternatives such as MBOs, specialist funds, commercial property etc. Higher-risk but significantly higher after-tax returns than VCTs.

[cprof]

Tim
Agree with Kidman's pros and cons, I would add one con in that it can be difficult to achieve diversification within your VCT portfolio because of the minimum subscription for new shares of around £5K. My own experience/perception is that most do OK ( taking into account initial tax relief and tax free dividends) but some have done spectacularly badly, although most of my horrors are in purchases I made 7-12 years ago.
I am a higher rate tax payer and my strategy is to max ISA and Pension contributions and then use other spare investment cash into VCT's up to my income tax limit. I have tended to hold beyond five years for reasons of overall portfolio diversification and because I would face 33% tax on other dividends. VCT's are about 20% of my total investment portfolio. If i were not a higher rate tax payer I would be more likely to sell after 5 years and re-invest in equities, commercial property etc.

[Retiringat51]

Excellent responses from all contributors.

[moorfield]

VCTs are opaque, expensive - in terms of fees etc , illiquid with large spreads and rarely deliver what they say they will.

Seconded. Liquidity. I think the first question VCT investors need to be asking themselves during the current will-we/wont-we Brexit shambles and a chancellor McDonnell looming is: "How do I get my money back?"

[TimR]

Many thanks for all of the excellent contributions.

As I have recently started receiving invitations from my platform (Best Invest) for investments - first in Mobeus VCT and now Unicorn Aim VCT I now feel much better informed. I assume the platform gets some sort of commission for selling VCTs ?

TimR

[BusyBumbleBee]

Many thanks for all of the excellent contributions.

As I have recently started receiving invitations from my platform (Best Invest) for investments - first in Mobeus VCT and now Unicorn Aim VCT I now feel much better informed. I assume the platform gets some sort of commission for selling VCTs ?

TimR

Oh, Tim - they're not invitations they are sales literature. Of course they make money from selling them to you and others.

[scotia]

Oh, Tim - they're not invitations they are sales literature. Of course they make money from selling them to you and others.

However financial intermediaries acting in an execution only capacity are usually are the cheapest means of purchasing new issue VCTs. Going direct to the VCT issuer is often a more expensive route. Don't ask me why!

[Kidman]

However financial intermediaries acting in an execution only capacity are usually are the cheapest means of purchasing new issue VCTs. Going direct to the VCT issuer is often a more expensive route. Don't ask me why!

Years ago I thought all commission was to have disappeared by now yet it is still there, hence this confusion.

As I understand it, the VCTs charge a different price when one buys direct instead of going through an intermediary. Such price is lower to reflect that they are not paying initial commission. However, the execution-only brokers typically rebate part or all of such initial commission to the shareholder putting them almost in the same position as if they had gone directly.

Taking Unicorn AIM as an example, the initial charge via a broker is 5.5% yet one can get initial rebates of 3% from Chelsea, ClubFinance, Hargreaves Lansdown and Tilney BestInvest. Page 20 of the Securites Note shows that in that case £10,000 would buy the same 6,009 shares as if one went direct. Although one gets the same number of shares by all the above means, the exception is that by going through ClubFinance one is eligible for trail commission rebates in cash.

[scotia]

However, the execution-only brokers typically rebate part or all of such initial commission to the shareholder putting them almost in the same position as if they had gone directly

the "almost" is frequently "better"
To avoid delay, this year I purchased Northern directly -and will pay a 2% initial charge. Had I gone through Hargreaves Lansdown, the initial charge would have been 4%, but HL would have provided a discount of 2.25%, hence I would have paid an initial charge of 1.75% As Kidman noted some Execution only brokers (not HL) also offer a share in the trail commission - which will be a small fraction of a percent over a few years
However I noticed that the current Baronsmead offers have an initial charge of 3% - with no apparent discount available through an execution only broker.

[BusyBumbleBee]

As I understand it, the VCTs charge a different price when one buys direct instead of going through an intermediary. Such price is lower to reflect that they are not paying initial commission. However, the execution-only brokers typically rebate part or all of such initial commission to the shareholder putting them almost in the same position as if they had gone directly.

When I bought my first VCT shares in 1996, my execution only broker charged me a flat fee of £25 per purchase and rebated all the rest. Quite a bargain but sadly no longer available as he has gone out of business - not surprisingly perhaps.

[Kidman]

When I bought my first VCT shares in 1996, my execution only broker charged me a flat fee of £25 per purchase and rebated all the rest. Quite a bargain but sadly no longer available as he has gone out of business - not surprisingly perhaps.

I used to get the same deal from Hargreaves Lansdown and not only for VCTs. I could put any sort of investment through them and they would rebate all bar £25. It was even easier prior to the days of regulation, I just put my own name down and got the commission directly!