Casting your net income a little farther out

Don't miss out on the technology boom, sidestep the high-risk bandwagon and take a long view with a venture capital trust.
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The Independent Online

The current stock market climate is more akin to a casino than an investment market. Risk is in fashion - big time. Investors are clambering over each other to pour their cash into technology and internet shares, irrespective of the risks that many of these ventures carry. Perversely, warnings that the dot.com bubble will burst only seem to fuel the stampede into these shares from investors hungry not to "miss out" before the action grinds to a halt.

Such frenzied buying has this month pushed a collection of relatively unknown (and in many cases loss-making) technology companies into the FTSE-100 club with household names such as profit-making Scottish & Newcastle, PowerGen and Imperial Tobacco being booted out into the backyard.

For many investors, chasing high growth investments in technology, the internet and biotechnology, the logical route will be through a unit trust fund. These have been selling like hot cakes in Individual Savings Accounts where all of the returns are free of tax. Fund management companies are hurriedly launching technology funds to jump on the bandwagon, but investors should probably stick with established specialists with clear track records such as Henderson, Aberdeen and SocGen. The best way to invest in these funds is through monthly savings schemes or a series of lump sums so that if, or rather when, the market in tech shares does crash, you won't have put all your chips on the table at the wrong time.

There are also a great many investors punting small individual high-tech shares directly in the hope of snaring a lifestyle-transforming winner. Many of these are quoted on the Alternative Investment Market and Ofex which have quickly established themselves as the Wild West of the share world.

Enter the twilight world of internet "bulletin boards" - sites on the web where investors can pin their opinions on different shares and exchange information. This is the world of speculators and day traders. Much of the information on bulletins boards is little more than "ramping"; upbeat messages encouraging investors to buy a particular share to push up the price. Rampers work on the premise that if you keep saying a share will go up, it becomes a self-fulfiling prophesy. The favoured investments of the bulletin board junkies are "internet incubators". These are companies who invest in other internet companies at an early stage. The movement in share prices of these incubators can be enormous with the likes of Oxygen Holdings launched this year at 2p and hitting a high of 65.5p. The valuation of many of these incubators defies all logic since in reality they are just funds structured in a very tax inefficient way. For example, an investment trust is a company which invests in other companies and because they are incorporated as trusts they don't have to pay capital gains tax on their share trading activities. An incubator company which, like an investment trust, invests in other companies, doesn't enjoy such tax advantages.

Most investment trusts trade at discounts. That means the price of their shares is lower than the value of the assets they are invested in. By contrast, internet incubators stand at ridiculous valuations often at 10 times the value of the assets they hold. Such shares aren't driven by basics, but by news and gossip.

For investors wanting a tax-efficient way into the tech story, Venture Capital Trusts offer much better value than overpriced incubators. Most VCTs invest in unquoted companies or companies quoted on the AIM, and many have a strong bias towards technology companies. To help offset the risks of backing young companies, VCTs offer a cocktail of tax incentives.

When you invest in a VCT launch, you get a 20 per cent income tax rebate. But the real attraction is if you have a Capital Gains liability because by investing in a VCT launch you can defer the payment of tax at your highest rate. That means for a top rate taxpayer the cost of £1 of VCT shares is effectively just 40p after all of the tax reliefs. While the original CGT liability is re-crystallised when you eventually sell the VCT shares, all of the gains on the VCT shares themselves are tax free.

Many of the new issues specialise in unquoted tech companies. This is the really attractive stage to get exposure because when they eventually come to the stock market their share prices can soar. Through a VCT you can enjoy a tax-free return.

VCTs are not suitable for most investors. They are designed for those who have CGT liabilities and are definitely not suitable for non-taxpayers or ultra-cautious investors. Smaller companies should never account for more than 25 per cent.

To enjoy the tax benefits you mustn't sell your VCT shares for the first five years, but in practice most trusts have their first wind up vote after seven years. Although VCT shares can be sold on the stock market they tend to trade at big discounts. As tech shares boom, many investors will be looking to avoid paying CGT to Gordon Brown. Ironically, by ploughing money back into technology companies through VCTs, they can do just that.

Jason Hollands is deputy managing director of independent advisers BEST Investment. Readers of The Independent can gain a free copy of their guide to VCTs on 0870 5 800222

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