The venture and development capital sector offers the chance to back new companies and high-flying entrepreneurs at the start of their careers. Pick the right fund, and you might just see its value go into the stratosphere, leaving all the other investment funds standing. Pick the wrong fund, and you could lose much of your capital.
This sector contains unit trusts that can invest in unquoted companies (meaning businesses that are not listed on the stock exchange).It also offers specialist investment trusts that invest in unquoted companies.
The funds in this sector work by injecting cash into firms, often after a management buyout where a private company is sold to its management; or management buy-ins, where outside managers are brought in. The funds make money from dividends from their investments, and then really cash in when a company in which they have invested either joins the stock market or is sold off.
Funds in some sectors will often have similar portfolios. In fact, their core holdings may even be the same. Not so in the venture and development capital sector. Here the 22 funds have completely different portfolios and investment criteria.
Under the investment rules, a fund can only have a maximum 49 per cent stake in a private company. A typical venture capital deal, however, may see the financiers taking an 80 per cent plus holding.
These venture capital managers do not like sharing their investments, even if this is occasionally necessary, so they get round it by having other "private funds" in their stable that will take on the extra stakes in any investment.
A private fund is not quoted on the stock market and is made up of pooled capital from institutional investors (banks and financial organisations).
There are also large differences in investment strategy. Some funds, such as Candover and Electra, back the very large pounds 100m plus deals that make the headlines, while others, such as Foreign & Colonial Enterprise and Kleinwort Development Capital, will only invest in small and medium- sized companies, those between pounds 25m and pounds 100m.
Most will not invest in start-ups (new companies with no trading record) or very high-risk sectors such as biotechnology. Yet by contrast, Mercury Grosvenor's track record is influenced by the early backing it gave to some of today's high-flying listed companies, such as Shire Pharmaceuticals and Shield Diagnostics.
Some funds, such as 3i, have a vast portfolio, while others have just 20 or 30 stocks. There is also a big difference in size of funds. The biggest are 3i capitalised at pounds 3.4bn and Electra at pounds 1.1bn.
Others are much smaller. For example, the successful Kleinwort Development and Mercury Grosvenor are both well under pounds 100m.
In the past there have been doubts about the valuations of unlisted investments. Under the auspices of the British Venture Capital Association, all funds now use the same yardstick for their valuations. This is done by applying a conservative comparison with similar public companies. When portfolio investments go on to the stock market or are sold off, then valuation is much easier.
So what does it take to produce a soaraway success such as Foreign & Colonial Enterprise? "It certainly paid off when we geared up the fund by borrowing money some eight or nine years ago," says Rod Richards, a director of F&C Ventures, the fund manager. "This money was invested in a number or companies that have now been floated at very good prices."
Among the companies the fund cannily picked were ComputaCenter, Game, Ottakers and PSD, which have all been floated recently. The pounds 289m fund still has a pounds 75m stake in ComputaCenter.
Unusually for a fund in this sector, the F&C trust has more than half its investments in companies that are now listed on the stock market. "Companies have joined the market at higher prices and multiples than we ever thought possible, which accounts for our performance figures," says Mr Richards.
"We usually sell up to half of our holding when one of our companies goes public, and a lot of our investments have joined the market in the last couple of years. This means that we are in an unusual position of sitting on a pounds 97m cash pile and having so much of our portfolio in listed equities. We shall be looking to invest this money in more good deals."
If you fancy the idea of supporting the companies of tomorrow, then one of the venture capital specialists could be worth a look. But do be wary. Make sure you know what you are buying; these collective funds should not be confused with Venture Capital Trusts.
VCTs are tax-efficient investments that attract basic rate income tax relief together with freedom from capital gains tax if the shares are held for at least five years. VCTs are subject to strict rules in return for the generous tax treatment and the funds only invest in small, mainly unquoted companies.
New VCT launches are for the relatively wealthy and adventurous who are looking for generous tax reliefs.
VENTURE AND DEVELOPMENT CAPITAL FUNDS
Top performers over 1 year
Foreign & Colonial Enterprise 101.6
Foreign & Colonial Private 39.1
Thompson Clive 30.4
Northern Investors 26.7
Mercury Grosvenor 25.9
3 i 22.7
Sector average 16.4
FT-SE All Share 22.2
Top performers over 5 years
Foreign & Colonial Enterprise 457.8
Kleinwort Development 223.1
Thompson Clive 186.5
Mercury Grosvenor 158.1
Gartmore Enterprise 148.9
Dunedin Enterprise 148.7
Northern Investors 148.6
Sector Average 145.6
FT-SE All Share 120.9
Top performers over 10 years*
Foreign & Colonial Enterprise 1,033.6
Pantheon International 375.0
Dunedin Enterprise 298.6
Kleinwort Development 281.6
JZ Equity 162.2
Abtrust Scotland 145.4
Sector average 371.5
FT-SE All Share 196.3
*There were fewer than 10 funds in existence in 1988.
All funds are mid-market to mid- market price with
net income reinvested.
Source: Reuters HindsightReuse content