29th June 2009

What Do Shareholders want from VCTs?

Taken from an article written by Albion Ventures and published in Investment Week

The attractions of Venture Capital Trusts (VCTs) have been highlighted recently following the tax incentives for high earners to invest were improved by Alastair Darling in the Budget. Whilst Alastair Darling made no material changes to VCT legislation, his adverse changes to the pension regime dramatically reduced the attraction of investments in pensions when compared to VCTs.

If you were to invest more than £20,000 in pensions during the next tax year, you only get tax relief at the basic rate. In VCTs however, you can invest up to £200,000 in the year and get tax relief at the rate of 30%.

We believe that this will be a good year for fund raising for VCT managers as higher earners use tax incentives to offset some of their increasing tax burden. Many of those that buy VCT shares in this tax year will be new to the asset class but a number will already own shares in other VCTs.

The pressure to reduce tax is an incentive to buy VCT shares but what do shareholders want from their VCTs once they own them?

The answer to this question is key, since keeping shareholders happy is the primary aim of any investment manager of a listed fund. At Albion Ventures we have over 12,000 shareholders invested across seven VCTs. We recently conducted a shareholder survey to find out how happy investors were with their investment manager and what the most pertinent issues were in relation to holding VCT investments.

We received nearly 1,700 responses which we were delighted with. Interestingly, 78% of our shareholders own VCTs managed by other companies so we feel this is a fairly representative snapshot of current VCT shareholder sentiment across the market.

We asked our shareholders a variety of questions, including anticipated holding periods, , how they viewed VCT allocations within their overall portfolios, and what (if any) legislative changes they would like the Government to make to VCTs. We also wanted to know how much of their portfolio is invested in VCTs, and importantly, whether they wanted to make a further VCT investment this year.

When asked how long they intend to keep their VCT shares, 65% of the responding shareholders planned to hold their shares indefinitely. A further 14% stated they intended to hold their shares for seven years. Only 3% stated they intended to sell their shares after three years and 18% after five. This is refreshing as we have always viewed VCTs as long term investments since we believe it takes around that amount of time for a portfolio to mature and a sustainable dividend stream to be created.

As an aside, the dividend stream is a vital component of sustaining the share prices of VCTs. Research we conducted in 2007 proved that steady dividends support the share price of a VCT and as the dust from the recession settles and share prices normalise we expect that scenario to return.

When asked whether they viewed VCTs as a supplement to pensions, ISAs or a standalone investment, 63% of shareholders answered that VCTs were a standalone investment, but one in four viewed them as a supplement to pensions. Interestingly, we along with many other VCT managers expect this position to change after the budget and expect a greater number of new shareholders to view VCTs as an alternative to pensions due to their greater flexibility and lower funding constraints.

The most important feature the shareholders were looking for was dividend yield, followed by capital growth and tax planning, with financial security coming in as the least important. Dividend yield is fundamental to our investment strategy so it was reassuring to hear that our investors’ expectations are in line with our objectives. However, it also re-enforces the view that investors buy VCT shares for tax-free income.

We asked the shareholders what changes to VCT legislation they would be interested in seeing and, perhaps unsurprisingly 55% wanted greater income tax relief, but 58% also wanted Inheritance Tax Relief. Only 15% of shareholders wanted a reduction in the current 5 year minimum holding period and one in three wanted fewer investment restrictions. The inheritance tax point is important as that would incentivise shareholders to invest for the long term, which we believe is in line with how the government views VCT investing.

Whilst, in our opinion, VCTs have in effect become the default tax planning investment for higher earners it is important that investors understand the longer term nature of VCT investing. Tweaking the tax rules to mitigate inheritance tax would not only reinforce that but would also attract a new form of shareholder which would help stimulate the sector.

The other factor that we think will boost VCT ownership going forward is that 94% of our shareholders have allocated less than 25% of their portfolios to VCTs, with 65% allocating less than 10%. In other words there is room for them to own more VCTs without creating concentration risk.

Looking to the future, 77% of our shareholders said they would consider investing in future VCT offerings from us, which is obviously good news for Albion Ventures. It is also good news for the market in general as 78% of our shareholders own other VCT managers’ shares. In addition, 76% of responding shareholders were satisfied or very satisfied with their Albion Ventures VCT returns, a very pleasing statistic.

To conclude; we are pleasantly assured that VCT shareholders appear to have a clear understanding of their investments and know what they want from them. The fact that most shareholders want to own their shares indefinitely and also want a dividend stream seems to indicate that, shareholders view VCTs as tax efficient income vehicles.

We hope that these opinions canvassed from existing shareholders will be indicative of how new shareholders participating in future fundraisings will think, particularly bearing in mind the relative future unattractiveness of pensions for higher earners.

With all this in mind, we believe the fundraising market for VCTs currently looks buoyant. In particular, the poor economic backdrop of ongoing lending difficulties and recession could be a good time for shareholders to invest in VCTs; returns on investments made by venture capitalists during bear markets have historically been very good.

We believe that poor pension tax benefits, strong investment returns and investors’ need for tax free income will increase the amount of money raised by VCTs, and that this should steadily grow year over the next three to four years. VCTs receive low allocations across existing shareholder portfolios so for clients with the correct aptitude for risk we believe they could become the default tax efficient investment.