Ian Cowie: trusts with tax appeal, but performance can disappoint

Venture Capital Trusts have plenty of attractions, but our columnist points out that buyers should beware the very wide gap in this sector between winners and losers.

The Budget makes many of us think about tax and legitimate ways to place our money beyond the grasp of HM Revenue & Customs (HMRC). So it was good news for an often-overlooked tax shelter that it boosted returns to investors in a stock market flotation this week that got off to a flying start.

Venture Capital Trusts (VCTs) are a minority interest compared to individual savings accounts (ISAs) and self-invested pension plans (SIPPs) but VCTs can generate big returns from small companies. For example, consider a tipsy tiddler that hit the AIM on Monday.

It is early days for Virgin Wines UK (LSE:VINO) but the online off-licence’s 15% premium to its listing price of 197p lifted spirits at Mobeus Income & Growth 2 VCT (LSE:MIG) where VINO is the largest holding. The coronavirus closure of pubs and restaurants has removed any taboo from uncorking a bottle or two at home and this business looks like another winner from the rise of online retail.

Nor was MIG alone in raising a glass to VINO’s first week’s trading on AIM. Three other VCTs managed by The Income & Growth VCT (LSE:IGV), Mobeus Income & Growth (LSE:MIX) and Mobeus Income & Growth 4 (LSE:MIG4) - all backed the 2013 Virgin management buyout and they owned over 36% of VINO at launch.

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IGV is the top performer in the Association of Investment Companies (AIC) VCT Generalist sector over the last year, with a total return of 33%. It is up 74% over five years and 277% over the last decade. To put IGV’s performance in perspective, the average returns from the VCT Generalist sector over the same three periods were 3.1%, 28% and 136%.

All four Mobeus VCTs are in the top 10 of this, the biggest of nine AIC VCT sectors, over the last year. So this management group plainly knows what it is doing at the smallest end of the investment companies’ universe.

Sad to say, I cannot claim the same for my two VCTs in the same sector; Northern 2 VCT (LSE:NTV) and Northern 3 VCT (LSE:NTN), which both returned about 6% over the last year. To be fair, their medium to long-term performance is better with both notching up 38% over the last five years and 161% over the last decade.

I should also admit that I invested in a hurry when facing a horrendous tax bill after escaping from working at a certain newspaper nearly eight years ago. Then, as now, the main appeal of VCTs was the ability to claim 30% initial or upfront tax relief - or when the investor completes her or his next self-assessment return to HMRC. Income-seekers will also appreciate VCTs’ ability to pay tax-free dividends.

Both features look good to anyone able to commit funds for the five-year minimum required by VCTs but I regret to say the capital performance has been disappointing. NTV and NTN shares sank on issue by percentages similar to the initial tax relief received and, eight years later, they remain 32% and 17% below the nominal or pre-tax relief original investments.

True, they have thrown off a lot of tax-free income since 2013 but their yields have shrunk in recent years, along with most businesses listed in London. Although they now stand at 5.8% and 4.4% respectively, I am not sure either yield is sufficient to hang on much longer with poor capital performance.

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There is also the suspicion that managers might be making more out of VCTs than many shareholders, with my pedestrian pair carrying ongoing charges including performance fees of 2.47% and 2.4%, according to the AIC. Some sectors are even more expensive, with the average ongoing charge in VCT Specialist: Environmental hitting an eye-watering 3.18% despite dismal returns of a loss of 0.7% over the last year. Shareholders may well be going green but not in the way we wanted.

More positively, VCT AIM Quoted is the top performer among these specialist sectors with total returns averaging 44% over the last year; 86% over the last five years and 187% over the last decade. Amati AIM VCT (LSE:AMAT) is the top performer in this sector over all three standard periods, yields 4.1% and still trades at an 11.5% discount to its net asset value (NAV).

So there is value to be found here but VCT buyers should beware the very wide gap in this sector between winners and losers. There is no point avoiding tax if you destroy capital to do so. You don’t need to be brave to invest in VCTs but it helps.

Ian Cowie is a freelance contributor and not a direct employee of interactive investor.

Ian Cowie owns shares in Northern 2 VCT (NTV) and Northern 3 VCT (NTN) as part of a globally diversified portfolio of investment trusts and other companies.