VCT guide

SOURCE: MICAP (AT SEPTEMBER 2019) 33 VCT CHARGES AND PRACTICALITIES Target Fundraises The amounts raised by VCTs in new rounds varies considerably but the average is around £15 million. This is based on the availability of new investment opportunities that satisfy the defined selection criteria of the particular VCT. On top of the stated target, VCTs can also specify an over-allotment amount which can be triggered if the VCT’s board notes strong demand that is likely to exceed the original target, where suitable investment opportunities can be identified. Performance information VCTs must produce full audited accounts and interim reports at a minimum, which offers a good amount of transparency. Some VCTs may issue quarterly reports as well, although this is not a requirement. However, VCTs often invest in small, unquoted companies which are illiquid and hard to value. The VCTs will generally value their assets in line with international private equity guidelines or similar, which can involve estimating a fair value for these illiquid investments, based on what someone might be prepared to pay for the business in an arm’s length transaction. However, VCTs may only value their portfolio every three or six months, and the valuation is an estimate of unrealised value. The purchase prices of similar businesses sold recently are sometimes used as a guide. This is less of an issue for AIM VCTs, because the underlying investments are publicly traded. Legal and regulatory status All existing VCTs are listed on the LSE, which means they must comply with UK company law (including the VCT directors’ compliance with their fiduciary duties) and the LSE’s Listing Rules (including the disclosure and transparency requirements and the Prospectus Rules). VCTs are also funds, which means that they will have certain regulatory requirements: • Under the Packaged Retail and Insurance-based Investment Products (PRIIPs) Regulation, VCTs are classified as PRIIPs. This means that the VCT must issue a Key Information Document (KID), designed to help investors to better understand and compare the key features, risk, rewards and costs of different PRIIPs. • VCTs are also alternative investment funds which gives them certain obligations under EU law, such as the requirement to provide investors and regulators with complete transparency over the risk profile of the fund. • For the purposes of the Retail Distribution Review (RDR), all VCTs are considered to be retail investment products and, therefore, advisers cannot receive adviser commissions. However, VCTs may facilitate adviser charging, as agreed between the investor and their adviser. • As VCTs are not FCA regulated funds, an investment into a VCT is not covered by the FSCS. The underlying investments are not covered by the FSCS. However, the VCT itself will be covered by both the FSCS and FOS in the event of it not being able to meet liabilities of investors and a claim is upheld. VCTs can be marketed and sold to ordinary retail investors. Typical fees and charges One of the challenges with making a meaningful comparison between different VCTs is the range of different fees and charging structures. Typically a VCT will have: INITIAL FEES – Initial fees to cover the marketing and promotion of a particular offer for investment – these are taken from an investor’s cash subscription so as not to penalise existing investors in the VCT. As a result, the amount of a client’s subscription available for tax relief will vary; AMC – An annual management charge (AMC) which is paid by the VCT to the VCT Manager for managing the investment strategy of the VCT; PERFORMANCE FEE – A performance fee paid to the VCT manager to reward performance in excess of a certain hurdle, which will be set out in advance; RUNNING COSTS - A VCT will also have its own running costs (including its operating costs, directors’ fees, and administration fees). These will include the annual management charges explained above, but the overall quantum of running costs is often capped by a VCT. Low fees in one area may be offset by higher fees in another area, so, when comparing charges, it is important to look at them in total. Many VCTs offer discounts to the initial fees via ‘early bird offers’ when the offer first opens or loyalty discounts to existing investors, in order to incentivise investment. Minimum subscription Minimum subscription levels typically range from £3,000 to £5,000. Typical target returns Some VCTs quote specific target dividends. These typically range from 3% to 5% per year, net of fees. Sometimes this is quoted as a fixed amount per share (e.g. 5p per share). While the overall risk profile of VCT investments has gone up as a result of the changes announced in the 2017 Autumn Budget, the risk profiles of the offerings still vary. Returns must be placed in the context of the risk, liquidity and level of charges when choosing the most suitable VCT for a client. VCT charges and practicalities INITIAL FEE 2.5% - 6% AMC 1.75% - 4.5% of the investment amount ANNUAL RUNNING COSTS 3% - 3.6% of a VCT’s net asset value (including AMC) ANNUAL PERFORMANCE FEE 20% of profits above a certain hurdle Most commonly applied fees Key Information Documents There are concerns that the PRIIPs regulation on KIDs is not drafted in a way that creates consistent results that do not mislead the consumer. In an effort to deal with this issue, in 2019 the Joint Committee of European Supervisory Authorities (ESAs) issued the following new wording to be included with KIDs: “Market developments in the future cannot be accurately predicted. The scenarios shown are only an indication of some of the possible outcomes based on recent returns. Actual returns could be lower.” In its 2019 Annual Report, the FCA said it would work with ESAs on a full review of the Regulatory Technical Standards under the Regulation, primarily focusing on KIDs.