It’s that time of year when share subscription offers for Venture Capital Trusts (VCTs) tend to be launched. One of the first is that for the British Smaller Companies VCT (BSV). This one that has shown a relatively good performance for a generalist VCT – share price total return of 225 over ten years according to the AIC compared with a sector performance of 136. It also has a high dividend yield and a narrow discount to NAV. However I have never liked their manager’s performance incentive fee arrangement and consistently vote against the Chairman, Helen Sinclair, who introduced it. But they are proposing to change it.
Currently the incentive fee is based simply on dividends paid – at the rate of 20% of those paid – so long as a dividend hurdle is met. There is also a hurdle for Net Asset Value (NAV) which has to be met, which presumably was intended to ensure that the NAV did not fall to too low a level. However, very high dividends can be paid by the company even though the company has lost money on many of its investments. In effect, dividends can be paid out and incentive fee based on them paid to the manager even though the company’s earnings do not cover the dividends. Incentive fees based on dividends paid out in VCTs are simply wrong.
What can happen is that dividends are paid out based on realisations, while ignoring the unrealised losses in the portfolio. This arrangement resulted in a very large incentive fee being paid to the manager in 2017 – dividends of 22.0p paid out when reported earnings were only 4.6p. The result was total management fees of £5.5 million paid when assets at the start of the year were only £96 million.
What is the new management fee arrangement? In essence it will remain dividend based with the same 20% figure. The only change is to introduce a Total Return hurdle to replace the Net Asset hurdle. There are other changes and complications to the incentive agreement which are very difficult to understand, including an overall cap, for which you need a spreadsheet to understand the effect. But the company says “Note that the historic incentive payments would have been significantly lower if the proposed incentive arrangements had been in place since 2009 due to this cap”. I’ll take their word on it, but it’s still a bad arrangement and should be simplified.
There is also going to be a reduction in the fixed “investment advisor fee” of 2% of assets so that only 1% is paid on cash balances held.
Shareholders may wish to vote for these changes as they may be better than the past arrangements but I suggest shareholders write to the Chairman as I shall be doing and complain that the board needs to try harder. This looks like an agreement that has been written by the fund manager. Incentive schemes for fund managers should be simple to understand by shareholders and the board, and not based on dividends paid out but on total return.
Roger Lawson (Twitter: https://twitter.com/RogerWLawson )
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