The changes affecting the pensions space in the UK – the tapered annual allowance, the closing up of lifetime limits – means that investors seeking to put more of their money away for their retirement have necessarily been turning to other tax-efficient methods in order to reduce their potential tax bill, writes Jack Rose, strategic sales director at Triple Point Investment Management.
One popular option has been venture capital trusts (VCT) which come with both income tax relief of 30%, tax-free income and are free from capital gains tax.
But popular as these reliefs are – and in today’s climate they are proving to be very popular – to suggest that VCTs are an alternative when it comes to pensions is somewhat misleading.
Instead, I would suggest that VCTs should rather be looked at as a supplement to any existing pension arrangements.
This is about incrementally adding to a pension pot rather than looking to replace anything else.
Diversification
The key to understanding venture capital trusts is contained within their name.
They are all about investing in early-stage companies where the potential returns are higher than might be the case in your other investments.
The key here – as with all investments – is diversification, and with VCTs this comes at two levels.
The first level of diversification comes with what the product offers investors. Your pension will consist of many elements, all vital for providing for your later years.
By adding VCTs, a pension investor will be giving themselves that extra element to add to their portfolio.
Now, these potentially higher returns don’t come without risks.
Basket of companies
The benefit of investing in early-stage companies is that you are getting in early, meaning that the valuation point is substantially different to what will be the case once a company has matured and been sold or potentially gone through a listing process.
The risk that comes with that is, of course, the fact that the failure rate of early-stage companies is higher than it is for mature entities.
The second level of diversification, alongside all the benefits of investing with experienced managers who know their way around the entrepreneurial space, is that they will also invest in a basket of companies.
The obvious point is that not all their eggs will be in the one basket. The risks will be spread around a number of companies.
While the manager will have faith in all of them, the inevitable vicissitudes of the business cycle might cause some of your investments to falter.
But not all and the diversification within a VCT portfolio will provide something of a safety net.
Chasing unicorns
There are implications to having this basket of potential winners. The managers will cast far and wide for their investments and they will be hoping to identify companies with great prospects and good management.
But what they will not necessarily be doing is seeking unicorns. These are the companies that tend to make the headlines in the financial pages and beyond.
They will be companies where their valuation as a private entity, after likely multiple rounds of funding, has breached the $1bn (£775m, €904m) mark. That dollar sign is important.
As befits their name, in the UK – as opposed to the US – such companies are rare beasts.
Indeed, at the last count according to researchers at Beauhurst there are only 21 unicorns to be found in the UK, of which 16 are active and five have exited – that is, either have been bought or have since floated.
This is about probabilities of outcome – important when we are talking about pensions. An average VCT will own between 3-20% of a company.
Even a small-ish VCT – say with a net asset value or NAV of £200m ($258m, €233m) – would need to source two or three unicorns in order to achieve the growth demanded of it.
But to mix the (albeit mythical) animal metaphors, if you are fishing in different waters and looking for opportunities further down the scale, finding companies that might hit exit valuations in the order of £100m is an easier task.
Wing and a prayer
It means that a small fund will get – that dreaded phrase – more bang for its buck at the lower end of the spectrum.
Now, some of the companies they will be invested in will indeed likely go on to be very successful businesses, and some part of your pension money will have been along for the ride.
But as befits an investment aimed at providing for your future, you won’t have been investing on a wing and a prayer.
Instead, you will have had the reassurance that your hits will make up for any misses, with the added satisfaction that you still got in at an earlier stage than most.
Moreover, with those tax relief kicking in, it even rewards you for taking the risk on, regardless of the outcome.
Incremental might sound boring but is a far better outcome for your income than chasing rainbows. And with the tax relief kicker, it starts to make a lot more sense
This article was written for International Adviser by Jack Rose, strategic sales director at Triple Point Investment Management.
