VCT managers hope to make several times their money on successful investments, and can often salvage something from those that do not go to plan.
Historically, most VCTs have made modest positive returns (excluding the tax relief); over the past 10 years, for example, the average VCT has returned 70 per cent, which works out as 5.5 per cent annualised, according to AIC/Morningstar data.
Admittedly, that average figure hides a wide range of outcomes, from 202 per cent to minus 67 per cent.
Aside from the portfolio approach, some risk is also mitigated by the fact that VCTs can hold up to 20 per cent of their portfolios in cash, which serves as dry powder to invest in new companies, or make further follow-on investments in existing ones. This also helps to dampen volatility.
The final factor that mitigates risk is that VCTs are managed by about 20 specialist firms, most of which have been running VCTs since around the time the scheme was created. They have considerable experience and track records you can examine to satisfy yourself of their credentials.
Because VCTs are listed companies, performance is transparent and readily accessible (for free on the AIC website, for example), which is simply not the case with most private market investments.
All that said, the risk of investing in venture capital cannot be magicked away entirely, so clients must be comfortable with that.
What is the profile of a typical VCT investor?
Some investors in VCTs are entrepreneurs themselves, or were in a former life, so they understand the risks and may even get a kick out of helping small UK businesses succeed.
Others are simply high earners who are unable to save much into their pension because of the tapering of the annual allowance, such as successful doctors, dentists, lawyers or headteachers – you do not need to be among the super-rich to make use of VCTs.
A final category of VCT investors are those who use them to supplement their income – some of whom may be retired. Remember, dividends are tax-free, and a mature VCT (we will come to what I mean by that later) typically yields in the mid-single digits.
Investors who enjoyed the 30 per cent tax relief while they were earning a living can simply hold on to their VCT shares in retirement and enjoy the stream of tax-free income – though of course it is not guaranteed. In this way, VCTs can be seen as supplementary to a pension.
Those who do not need that stream of income can reinvest in more VCT shares, if they choose, claiming 30 per cent tax relief on the reinvested dividends.
