VCT guide

41 40 RESEARCH AND DUE DILIGENCE RESEARCH AND DUE DILIGENCE Assessing VCTs As well as assessing clients’ suitability for a VCT investment or investments, advisers must also assess the range of offers available in the market, carry out due diligence and select the most appropriate investments for their clients. In assessing VCT offers, there are a number of areas advisers need to cover and advisers should document their assessment of each of them to create a thorough research and due diligence process on record. The first step is to assess the VCT managers operating in the marketplace and the VCT offers that are open to investment. A lot of VCT managers are likely to offer EIS and perhaps Business Relief (BR) investments as well (and their assets under management may reflect this), so their boards and investment committees will be looking at this wider horizon of investments, tax wrappers and investment sectors. Step 1 Evaluating the manager The following aspects are specific to the VCT Manager: Financial stability - as VCTs are designed to be held for a minimum of five years, the financial stability and trading history of a VCT’s investment manager can be a consideration. However, as VCT investment managers must be authorised and regulated by the FCA, they will have minimum capital adequacy requirements. Their deal flow access and investment selection process - do they see enough of the market to get the best deals and how much consideration is given to the merits and potential of the companies? If there is not sufficient deal flow, there is a temptation for the manager to invest in opportunities that do not fit their stated investment mandate, that are more risky than deals they would normally invest in or at higher valuations (making it harder to earn returns). Their track record of investment performance, exits and ensuring their investments retain VCT-qualifying status. Relevant sector expertise and ability to adapt to changes in rules and regulations. Experience - the investment manager’s experience in this field, along with that of their investment committee, is critical. The changes in VCT rules announced in the Autumn 2017 Budget have also introduced the possibility of some managers that previously focused on VCT investments targeting low risk, capital preservation strategies, having to pivot their activities. This means it is important to review the relevance of their track record to their current investments. Step 2 The next step is to assess the performance history of the VCT (if it has one). However, past performance is not a guide to the future and while many VCTs have a ‘target dividend’, dividends are variable and are not guaranteed. A VCT offer comprises new shares in: • A new VCT; • An existing share class in an existing VCT; or • A new share class in an existing VCT. The performance of a VCT can be assessed by considering the dividends previously paid by the VCT. However, dividends paid should not be considered in isolation – if the VCT’s Net Asset Value (NAV) per share or traded share price has fallen more than the amount paid in dividends, then the investor may have made an unrealised loss over that period. Performance metrics Two main metrics are used to measure and compare the performance of VCTs: • The share price total return - the value of any dividends paid plus the difference between the current share price and the price at which the shares were issued, expressed as a percentage of the original investment amount; • The Net Asset Value (NAV) total return - the value of any dividends paid plus the difference between the current NAV per share and the NAV per share when the shares were issued, expressed as a percentage of the original investment amount. Where a share price total return or NAV total return is calculated, it typically assumes that dividends are reinvested. However, some VCT managers may publish their NAV returns as a cumulative return, i.e. with dividends added but not reinvested. Whatever method is used, it is important that comparisons are made on a like-for- like basis. The traded share price can fluctuate with market sentiment, whereas the NAV per share is based on the value of the VCT’s net assets. For this reason the NAV total return is generally considered to be a more reliable indicator for assessing the performance of a VCT’s investment strategy. “Advisers can rely on factual information provided by other EEA-regulated firms as part of their research and due diligence. However, they should not rely on the provider’s opinion, for example, on the investment’s risk level.” THE FCA’S THEMATIC REVIEW ASSESSING SUITABILITY: ‘RESEARCH AND DUE DILIGENCE OF PRODUCTS AND SERVICES’ FEBRUARY 2016