US markets are replete with dynamic technology companies; Europe’s are staid and boring. Or so many investors think. But this is not entirely accurate. On the continent, for instance, tech companies now boast a bigger market capitalisation than banks and energy companies.
In Britain, on the other hand, investors seeking burgeoning, earlier stage businesses tend to go for the private firms found in listed portfolios such as the Chrysalis investment trust, which has been a top performer in recent years. However, there is also the long-established venture capital trust (VCT) sector. According to investment services group Wealth Club, these tax-efficient listed funds are increasingly investing in the same kind of fast-growing, valuable companies you’d expect to find in the Chrysalis fund and bigger rivals such as Baillie Gifford’s Scottish Mortgage trust.
Targeting fast growers
In 2015 changes to the VCT rules required all new VCT investments to be made in younger companies seeking growth capital. Since then, VCT portfolios have started to catch up with the reality that the UK is Europe’s top market for scale-up firms (those with more than ten employees and growing sales by at least 20% a year). A record £10.1bn was invested in UK technology companies in 2019; 81.2% of this went into high growth, high productivity scale-ups. According to Jonathan Moyes, head of investment research at Wealth Club: “If you look at many of the VCTs today they are arguably full of exactly the types of companies you want to be invested in, ie, fast-growing tech-enabled businesses whose business models have been accelerated by Covid-19”. Moyes divided ten VCTs’ constituents into three categories: those experiencing a decline in revenue; companies with revenue growth of 0%-25%; and finally, firms with sales growth of over 25%.
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Nearly half (45.7%) of the invested assets of the VCTs are in companies growing revenues by more than 25% year on year, on average. By comparison, just 4.6% of the largest 350 constituents of the UK main market have achieved this. About 22.5% of the invested assets of the VCTs are in companies that have grown revenues by over 50%, compared with just 2% for the UK main market.
Another way of gauging this transformation is to look at the Fast Track list of the 100 UK tech firms with the fastest-growing sales over the past three years. VCTs have invested in 15 of them. They include number seven, Elvie, a female-health technology developer, owned by the Octopus Titan VCT (LSE: OTV2), and number 21, Matillon, Britain’s take on Snowflake, the cloud-based data-storage company, owned by the British Smaller Companies VCT (LSE: BSV). Personalised stationery retailer Papier, number 28, is a holding of the ProVen VCT (LSE: PVN).
Generous tax relief
Crucially, that focus on growth businesses comes with all the tax benefits of a VCT. Investors receive up to 30% income-tax relief on the initial investment; £60,000 income-tax relief on the full VCT allowance of £200,000. Any dividends and capital gains are also tax-free. Investors can sell their stake in a VCT after the five-year minimum holding period, reinvest the proceeds in another VCT and receive a further 30% income-tax relief.
Of course, investors get those tax benefits because this is high-risk stuff. Moyes concedes that “VCTs are without doubt risky. They invest in early stage businesses that often fail and VCTs... are pretty illiquid. However, when you are exposed to... 70 or even 100 companies (as is the case with some of the larger VCTs), that risk is mitigated, especially if you... invest over a number of different VCTs each year.”
And despite the changes in portfolio composition, there are still plenty of businesses that are a tad pedestrian in growth terms. Moyes says “over time we expect mature investments to be gradually sold down, and for new early stage high-growth investments to become an increasingly dominant part of a VCT portfolio. In the meantime, those older-style investments can help to
manage risk and support dividend payments.”
Aim VCTs could hit the target
Note too that many of the fund management firms that focus on VCTs aren’t exactly in the top tier of global venture-capital firms and funds, both in the tech and life-sciences sectors. Outfits such as Draper Esprit and Baillie Gifford have a world-class reputation for bringing unicorns to the main markets. In particular I would also emphasise that in the life-sciences, where the UK has a fantastic reputation, specialists such as Syncona – a listed UK fund – probably have access to deals that many VCT specialists would never see.
Then again, perhaps I am being a little too harsh. The Aim VCTs in particular have a sterling record of investing in listed biotech firms. We saw gains in net asset value (NAV) of between 20% and 40% in 2020 for the likes of the Amati Aim VCT (LSE: AMAT), where life-sciences businesses comprise 31% of the portfolio, and the Unicorn Aim VCT (LSE: UAV), 27%. Around 30% of the Hargreave Hale Aim VCT (LSE: HHV), meanwhile, is in healthcare.
If these funds keep thriving I’d expect the VCT sector to attract more attention. With just 20,000 individuals claiming income-tax relief on VCTs last year, there’s a long way to go to build market share among additional and higher-rate taxpayers.
Max has an Economics degree from the University of Cambridge and is a chartered accountant. He worked at Investec Asset Management for 12 years, managing multi-asset funds investing in internally and externally managed funds, including investment trusts. This included a fund of investment trusts which grew to £120m+. Max has managed ten investment trusts (winning many awards) and sat on the boards of three trusts – two directorships are still active.
After 39 years in financial services, including 30 as a professional fund manager, Max took semi-retirement in 2017. Max has been a MoneyWeek columnist since 2016 writing about investment funds and more generally on markets online, plus occasional opinion pieces. He also writes for the Investment Trust Handbook each year and has contributed to The Daily Telegraph and other publications. See here for details of current investments held by Max.
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