Could diversifying your VCT portfolio be a powerful way to manage risk?

Paul Addison

Paul Addison

Private Client Director

Since their introduction in 1995, Venture Capital Trusts (VCTs) have become popular with investors thanks to their attractive tax incentives.

A VCT is a private equity fund whose shares are listed on the London Stock Exchange. They exist to provide funding to new and growing businesses.

To qualify for funding from a VCT, a company must meet certain criteria. For example, they typically:

  • Can’t have gross assets of more than £15 million at the time of the investment
  • Must have fewer than 250 full-time employees (or fewer than 500 for a “knowledge intensive” company)
  • Can’t be more than seven years old.

Certain industries are barred from receiving VCT funding too, and there are limits on how much a VCT can invest in each company.

The government considers the growth and development of these new businesses crucial to a healthy economy. As such, they offer significant tax incentives if you invest in VCTs. So, they may be an important part of your portfolio.

That said, they could carry more risk than other investment products and you might need to find ways to mitigate this.

Read on to learn about the tax benefits of VCTs and how diversifying could be a powerful way to manage risk.

VCTs offer several tax benefits to investors

The government offers several tax benefits to encourage more investors to purchase shares in VCTs and provide funding for new companies.

You can invest up to £200,000 in VCTs in the 2023/24 tax year and receive 30% tax relief on your investments. This equals a maximum of £60,000, so if you invest the full amount in VCTs each year, you could significantly reduce your Income Tax bill.

You may also receive other benefits including:

  • No Capital Gains Tax (CGT) on any profits derived from VCT investments
  • No Dividend Tax to pay on dividend income from VCTs.

These tax benefits could make VCTs very attractive, particularly as the CGT Annual Exempt Amount and the Dividend Allowance are set to fall for a second time on 6 April 2024.

This could mean you pay more tax on your non-ISA investments in the future but VCTs may offer a way to reduce your bill.

However, you should note that:

  • You must hold VCT investments for five years to retain the tax relief. If you sell the investment before this, you may have to repay any reductions in Income Tax.
  • The initial 30% tax relief is only available when investing in new VCTs, not when purchasing shares on the secondary market. However, you still receive tax-free dividends and do not pay CGT when disposing of shares, even if you buy them on the secondary market.
  • The tax-free status of the shares can be removed if the companies the VCT invests in no longer meet the qualifying criteria.
  • Tax rules are subject to change in the future so VCT investments may not remain as tax-efficient as they currently are.

Despite these caveats, VCTs may be a useful way to help you build a more tax-efficient portfolio. However, it’s important to be aware of the level of risk you adopt when investing in VCTs.

VCTs may fluctuate in value more than other investments

VCTs can offer investors the opportunity to benefit from the significant growth of developing businesses. Some hugely successful companies such as Depop, Zoopla, and Graze got their start from VCT funding.

However, many companies in VCTs do not see this level of success. Growing and developing a business is often a risk, especially in the early stages of the company. As a result, many of the companies backed by VCTs could fail during transitional periods, while others see rapid growth.

That’s why VCTs can represent a higher-risk investment investment compared with other options because they may be more prone to volatility.

VCTs may also require more oversight from fund managers and, consequently, they often have higher charges than other funds.

The good news is that, by diversifying your VCTs, you may be able to spread some of the associated risk.

62% of VCT investors purchased shares in at least two VCTs in 2022/23

Diversification across sectors, geographical areas, or asset classes is a key concept in investing and it can be an effective way to manage risk.

You may assume that VCTs are already quite well diversified as they invest in a range of different businesses. However, that is not necessarily the case, and it may still be important to diversify your VCT holdings.

A report from FTAdviser suggests that some investors already take this approach to VCTs. Statistics revealed that 62% of investors purchased shares in at least two VCTs in 2022/23.

There are several reasons why investing in multiple VCTs could help you spread risk.

As discussed, VCTs can be volatile and there is a possibility that companies within the VCT will fail. A VCT can invest up to 15% of its funds in a single company and some focus on a small number of large holdings. In this case, if a few of those businesses were to fail, the price could fall quickly.

By investing in several different VCTs, each funding different companies, gains from successful investments may help you mitigate losses elsewhere. It may also be useful to invest in VCTs that have lots of smaller holdings, as well as those that focus on a few key businesses.

Spreading your investments in this way could also mean that your wealth is exposed to a wider range of companies in different sectors or geographical areas.

If you are concerned that your VCT portfolio is not adequately diversified, you may need to make adjustments.

Often, you build up your VCT portfolio over several years. You may want to consider purchasing shares in a new VCT each tax year to diversify your portfolio over time and potentially mitigate risk.

To find out more about how a financial planner can provide valuable support, please get in touch. You can contact us online or call 020 7400 4700 for more information.

Please note

This article is for general information only and does not constitute advice. The information is aimed at retail clients only.

Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.

The Financial Conduct Authority does not regulate tax planning.

The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.

Venture Capital Trusts (VCTs) are higher-risk investments. They are typically suitable for UK-resident taxpayers who are able to tolerate increased levels of risk and are looking to invest for five years or more. Historical or current yields should not be considered a reliable indicator of future returns as they cannot be guaranteed.

Share values and income generated by the investments could go down as well as up, and you may get back less than you originally invested. These investments are highly illiquid, which means investors could find it difficult to, or be unable to, realise their shares at a value that’s close to the value of the underlying assets.
Tax levels and reliefs could change and the availability of tax reliefs will depend on individual circumstances.

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