The 2017/18 tax year was like no other for venture capital trusts (VCT) and Enterprise Investment Scheme (EIS) fund managers – and perhaps one many will be glad to see behind them. At the same time, many advisers may perhaps be looking forward to a new year on a level business playing field.
The last tax year brought the dual beasts of MiFID II and significant rule changes to the tax-efficient investment industry. In contrast, the 2016/17 tax year saw strong inflows into EIS and VCTs, with the latter delivering the second-highest rate of inflows ever recorded, as relevant pension rule changes began to bite.
As the 2017/18 tax year unfolded, however, we saw the launch of the consultation on the Patient Capital Review. This created a ‘buy now while you can’ sales frenzy that was in full force for many VCT and EIS funds who feared their investment strategy would be affected or tax reliefs would be shredded.
Although these fears ultimately proved unfounded in some cases – particularly with VCTs, where tax reliefs remained untouched – the result was an unprecedented level of cash raised in the historically quiet pre-Christmas period.
According to Wealth Club, VCTs raised around £728m in 2017/18, which compares with £542m in 2016/17 and is the second highest level on record – falling behind only 2005/06 when investors ploughed £779m into VCTs as tax reliefs decreased. Total VCT assets under management at 5 April 2018 stood at £4.3bn – up from £3.9bn the previous year.
Several VCTs closed early and the window for VCT investing certainly felt a lot shorter than previous years, as investors piled into VCTs pre-Budget, in the belief tax reliefs may alter.
With large fundraisings, of course, come questions over deployment, deal flow and cash drag. This tax year, cash ratios will become far more important to advisers choosing VCTs for their clients.
Trend to growth
According to research firm Tax Efficient Review, the trend – as expected – is towards growth. Investments into growth-focused funds were up on the previous year although ‘limited life’ funds did raise significant amounts in the run up to the Budget.
The rise of growth reflected the rule changes and lack of alternative products but it is also more an acceptance that, if clients want EIS exposure, they have to take on more risk. Again, this should be good news for UK plc.
This also coincided with a realisation that some growth funds are delivering the returns whereas the so-called ‘lower risk’ funds were actually higher-risk than they were positioned with investors.
So what about this tax year? Well, the market has changed as the new ‘risk to capital’ condition for EIS and VCTs has increased the risk profile. Some investors will not be prepared to take that risk so we might see an overall fall in the EIS and VCT market in 2018/19.
For our part, we see three potential changes in the market:
* First, the potential creation of a new ‘Approved EIS’ fund structure, which might open up growth investing to a whole new subset of investors as reduced administration and clearer tax planning will assist the financial advice process.
* Second, VCTs will see more pressure on deployment under the rules and this might impact fundraising for this tax year. This might result in new entrants entering the market, with one already announced this tax year. Advisers might then have to make decisions earlier than usual to avoid missing out as VCTs close early.
* Third, with some sounding the death knell for ‘asset-backed’ investment, advisers may need to re-educate clients to think of EIS and VCT as being synonymous with growth, and that generous tax reliefs require capital to be at risk – but also that the returns can be attractive, regardless of the tax benefits.
While it will take time for the new rules to bed in, at least the uncertainty over EIS and VCT has gone. And it has been extremely positive to see the Chancellor recognise the valuable role of EIS and VCT funds in the UK economy.
The government wants more of this capital to focus on growth investments. For advisers, this might require more research on funds and more education of clients, but the move is good for growth managers, positive for investors will want a growth kicker and great for UK plc.
Tom Hopkins is co-founder of Kin Capital