Investors' eyes on the VCT prize

The 2013/14 venture capital trust (VCT) fundraising season made an exceptionally strong start, with the three Northern VCTs raising their full £50 million target by the end of November. The Northern trio's impressive long-term returns encouraged their 1,270 existing investors to put up £22 million of the funds raised.

The rest came from new supporters, some of whom seem likely to have turned to VCTs because of the reduced scope for tax relief through pension contributions. In addition, well-established generalist VCTs are attracting a growing following among those seeking a relatively high and long-term tax-free income.

The 5% target of most current offers is a little lower than the anticipated yield on the Northern offer, but nonetheless tempting. It is equal to 7.1% tax free on the net cost of investment less the 30% tax relief available to UK tax payers on purchases of newly issued VCT shares, and it compares handsomely with the returns on offer from annuities, bank savings accounts, and investments in most shares, trusts, funds and investment-grade bonds - all of which can be taxable.

VCT virtues

In addition, VCTs have scope for capital growth as well as income, though the former is likely to be modest, as a lot of capital gains are distributed as income.

A further reason for the growing enthusiasm for generalist VCTs is that their managers have been talking-up the exciting investment and realisation opportunities they are seeing as economic prospects pick up and bank lending for smaller companies remains restricted.

The main caveat is that VCTs are not risk free. They must invest at least 70% of their assets in newly issued shares or the securities of unquoted or AIM-quoted UK companies with total assets of less than £15 million and less than 250 employees. Such small companies can prove fragile, and almost every VCT has backed some losers.

However, successful smaller companies can prove exceptionally rewarding investments, and the risks can be mitigated by portfolio diversification and the skills of a VCT manager. A manager's credentials must therefore be carefully considered, especially as they collect annual fees of more than 2% and may also earn performance fees.

The Northern VCTs invest mainly in larger, better-established companies within the parameters open to VCTs. They have set their annual distributions at a level that they expect to prove sustainable and which should allow them to at least maintain their net asset value per share. The Baronsmead VCTs have a similar approach, and their 2014 offer is expected to be popular.

Highly rated

The VCTs included in this season's Maven and Octopus Titan-linked offers also focus mainly on companies at the larger end of the VCT size spectrum, as do the four Mobeus VCTs. The current Mobeus-linked offer targets a relatively low yield but has attracted very positive ratings. It is reviewed overleaf.

Subscribers to the Albion Ventures-linked offer can receive an income payment every month. Another special feature of this offer is that around 60% of Albion's investments are in loans secured on assets, mostly property. The property connection held back returns over recent years, but Patrick Reeve, who heads the management team at Albion, says it is now starting to come right.

Albion is one of the largest VCT managers, and subscribers to the linked offer are effectively taking a stake in a single VCT with assets of £230 million invested in around 75 companies, so it is well diversified. All the investee companies are ungeared, apart from their loans from Albion, and they are predominantly in sectors expected to grow significantly over the next decade, such as healthcare and renewable energy.

Reeve says the four Albion-branded VCTs have put a high priority on maintaining their dividends in recent years, at the expense of their net asset values, and the emphasis now is on restoring their NAVs per share to at least 100p.

Adventurous choice

The Foresight VCT offer could appeal to investors ready for a more adventurous approach, with potentially higher, if more volatile, total returns. The VCT backs smaller companies than Baronsmead, Northern and Mobeus, and manager Foresight Group claims this gives it a wider choice of opportunities in a market segment where growth can be rapid.

It reports that most of its established holdings are doing well, as are its recent acquisitions, and it is seeing a strong deal flow of attractively priced opportunities. It is therefore seeking to increase its issued capital by up to 72%.

Some of these companies make annual profits of more than £2 million on revenues of more than £20 million, so they are far removed from the plucky minnows often associated with VCTs."Mark Wignall

Launched in 1997, Foresight VCT benefited early on from being technology oriented, but it has become more diversified. Around a third of the current portfolio is in electronics and advanced engineering, a quarter is in software and another quarter split between consumer goods and IT services.

It has an outstanding long-term record, and its five-year returns are also good, despite a difficult run in 2013. With only 17 holdings, one of which accounts for 22% of assets, it is unusually concentrated and returns are liable to be lumpy. The low minimum investment might attract those seeking a bit of diversification from more risk-averse VCT exposure.

Proven VCT similarly focuses on smaller growth companies, which it looks to shepherd through a growth spurt and sell on within four years or so, typically to a larger company. It too has a good long-term record, but recent progress has been dull, and short-term returns could be limited by cash drag, as the portfolio was less than 60% invested prior to the current fundraising.

Its outstanding feature is the portfolio's 50% exposure to the fast-growing digital media sector. Manager Beringea claims its expertise in the sector helps it source a lot of opportunities and evaluate them effectively. However, funds raised this year will be used to increase diversification.

The target dividend of 5% of NAV per share is expected to be consistent with maintaining a broadly stable NAV per share over time. Special dividends will be considered when realisations have been exceptionally rewarding.

One of the two British Smaller Companies VCT offerings has an excellent record, so its linked offer may be worth considering. Like the Baronsmead offer, it is unavailable at the time of writing.

Dark-horse alternative

The offers mentioned so far in this article aim to provide additional funds for established generalist VCTs. Newly launched generalist VCTs are rare, as their investment parameters are subject to the latest regulations, and these tend to be more restrictive than the rules governing money raised some time ago. In addition it can take several years for a generalist VCT's portfolios to mature sufficiently to pay out attractive distributions.

With that in mind, interest in the new Time:Reboot VCT seems likely to be restricted mainly to those with a strong belief in the commercial nous of ex-military entrepreneurs or a charitable wish to support them.

Mobeus makes mark in management buyout niche

Mark Wignall, who heads the team at Mobeus Equity Partners, says its VCTs are exceptionally conservatively managed. The team invests almost exclusively in well-established and profitable companies, and more than 90% of funds are in management buyouts.

He comments: "We are the most management buyout-focused VCT managers in the country. This reduces the risks, as we are coinvesting with incumbent managers who know where the investee company's problems and opportunities are. They are savvy buyers who risk their own money, and their interests become aligned with ours.

I prefer to under-promise and overachieve."Mark Wignall

"Some of these companies are making annual profits of more than £2 million on revenues of more than £20 million, so they are far removed from the plucky minnows often associated with VCT investment.

"Many have substantial export sales and nearly all are niche companies in niche markets, which enhances their pricing power."

Mobeus was originally an autonomous business unit within the Matrix Group, but completed an MBO in 2012, five months before Matrix went into administration. The team has focused exclusively on VCTs since 2004 and is the seventh largest VCT manager.

Wignall says current market conditions are good for investment, but the team remains highly selective. It raised £25 million through last year's linked offer and invested £30 million in five transactions in 2013, including the MBO of Gro, the leading baby sleep bag provider in the UK and Australia, and Virgin Wines.

This used some of its cash reserves, which are maintained at a high level to ensure it can cover dividend payments, running costs and finance share buybacks to keep discounts in single figures. However, Wignall hopes this year's fundraising will allow it to invest even more in 2014.

The targeted dividend of 4p is below the average level recently achieved by the Mobeus VCTs and is expected to be exceeded. "I prefer to under-promise and overachieve," says Wignall.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.