The AIC have published a note that says that a record amount of money was raised by Venture Capital Trust (VCTs) in the last tax year. It passed the £1 billion mark for the first time.
This may not be surprising given that investors may have realised gains from stock market investment in last year and VCTs have been looking attractive because of good reported profits and the available tax benefits. But one issue that has yet to become clear is the impact on the long-term performance of VCTs under the new investment rules. The investment rules for VCTs changed so they now have to invest in early-stage companies rather than asset-backed companies or management buy-outs of mature businesses. This has meant that they are now investing mainly in immature technology businesses whose valuation is often problematic. And the valuations often depend on the last fund raising round rather than on the profits of the business.
The problem is that the valuations of juvenile technology businesses have been rising and you can see that from the comments of fund managers who have been finding the valuations of such businesses have been rising. They have been competing harder for new investments. If they are paying more for companies this might affect their long-term returns in due course.
More money piling into VCTs actually makes the situation worse as the cash has to be invested rapidly.
In the meantime, the reported profits of VCTs often depend on unrealised gains rather than realised ones based on fund raising rounds and comparable companies. They have been able to achieve a few good realisations which enables them to pay good dividends but that simply reflects the enthusiasm for technology businesses in the last couple of years.
I am not saying that VCTs are necessarily a bad investment at this point in time – I did purchase a few more VCT shares last year. They do provide some diversification in a portfolio and have good tax benefits even if there is a risk that the Government might reduce the latter in future. But investors do need to consider them as long-term investment vehicles and do need to be wary of the above issues.
The AIC Press Release is here: https://www.theaic.co.uk/aic/news/press-releases/smes-to-benefit-from-record-funding-as-vcts-raise-over-a-billion-in-202122
Roger Lawson (Twitter: https://twitter.com/RogerWLawson )
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Indeed recent performance has been good, but that’s often been a result of selling the investments made under the old rules. Investors may not realise that this benefit is one-off, and further realisations may be a long time away as earlier-stage investments are made to replace them.
Adding to that the high cost headwinds faced by investors in the sector, and the presence of the odd rascal, the VCT sector is not as attractive to me as it could be.