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Market for venture capital trusts opening up

Scarce availability of income investments from traditional sources is leading to an increase in trading on the notoriously illiquid secondary-market for venture capital trusts (VCTs), traders are claiming.

While activity remains low, investors are beginning to look at VCTs on the secondary market following consistent dividend payments from these vehicles in recent years, which have shown an ability to deliver consistent income levels.

Michael Bellamy, head of trading at Singer Capital Markets, is among those who have witnessed an uptick in activity on the secondary market.

He explains: "As a trend, it is certainly growing. A number of VCTs have been stating their dividend policy for a few years now and some have now got a proven track record.

"Some of the managers who do not have an active buy-back policy or discount control mechanism have found their discounts are quite wide and at the sort of level of 30 to 40 per cent, investors are finding that attractive."

Traditionally, VCTs are front-of-mind only towards the end of the tax year when new issues are made as they offer 30 per cent relief on initial investments of up to £200,000 as long as the shares are held for five years.

Diversifying income sources

This uplift in secondary market activity, while small, could result in wider recognition for the vehicles to retail investors.

Patrick Connolly, a financial planner at AWD Chase de Vere, says while the news is encouraging, investors still need to be careful about the implications of buying on the secondary market. He notes: "There has been an increase in the secondary market for VCTs but it is still extremely small, which is why, when you look at the generalist VCTs, there are still many big discounts. However, some of them, like the Baronsmead VCTs, aim to keep the discount at around 10 per cent because of their buyback policy.'

Connolly says there are advantages for those investors willing to give the secondary market a go, however.

He says: "Timing isn't so relevant because secondary products are around on an ongoing basis and you can buy into an established portfolio. Therefore, you can jump into an income stream although you lost out on the initial tax advantages."

Advisers agree that while dividend policy has been proven by some VCTs, a combination of capital growth and income is still hard to come by for many, and this is still hampering faster expansion of the secondary market.

Connolly explains: "I can see why there is a stronger secondary market for some of the better-quality VCTs, but not for the whole market. I think some VCTs still haven't proved themselves to be consistent in terms of retention of capital and dividends."

Matthew Woodbridge, head of investment products at Chelsea Financial Services, agrees that activity on the secondary market is on the increase and admits to having bought VCTs this way himself.

He says: "I am not saying that it is going to explode in the next six months, but it is something that people are becoming more and more aware of. It is quite clear who the winners and losers are.

"Some VCTs have even reduced their dividend policy but still, the yield they are getting when you gross that up is very compelling. For high net worth individuals who are looking to diversify their sources of income, some of these trust have been consistent."

Picking a winner

For those investors wanting to try the secondary market for the first time, there are some vital considerations before buying in.

Looking at the quality of assets is key. Many of these funds now have long track records, so investors can see what recent investments have been made and note any significant changes to the portfolio including disposals.

The experience of the investment manager is also vital, and this has led to a shake-out in those underperforming managers in recent years when a VCT's board has decided to change manager in favour of one with a better track record.

As a rule of thumb, the most consistent VCTs that are established tend to have the most assets under management.

Investors should also check when the date when the net asset value (NAV) was last published. If it is fairly recent, you should be able to rely on the fact that it is accurate. If its old, you should take into account what has happened in the economy and in the wider market generally.

Chelsea Financial Services' Matthew Woodbridge says this is a factor, as is the VCT's management of the discount. He explains: "Generalist VCTs such as Northern Trust or Baronsmead pay out very steady discounts and there is a lot of transparency in the portfolio. Those companies have strong buy-back policies so the investor has the comfort of knowing, if they want to sell it, they can get out of the stock if they want to."

For the most part, it is unlikely that you will ever realise the NAV unless the company winds up in future and most VCTs have no intention of doing so, so the NAV should not be viewed as an exit strategy.

Specialist VCTs are widely recognised as being more risky than those in the generalist sector. While this doesn't necessarily mean that they are bad, it should be kept in mind.

This research is taken from the June issue of "Business XL" magazine, which is published on 10 June.

Understanding VCTs

Venture Capital Trusts (VCTs) are companies listed on the London Stock Exchange, which are run by fund managers. They can invest in companies which are unquoted, on the Alternative Investment Market (AIM) or on the Plus Stock Exchange. Investors can subscribe for, buy and sell shares in a VCT, which invests in trading companies to enable their growth and development. They invest in UK companies, but no single investment holding can be more than15 per cent of a VCT's overall assets.

VCT dividends are exempt from income tax and there is no tax to be paid on VCT profits.