There are three types of VCT. Generalist VCTs invest in a variety of companies in different sectors and at different stages of development. AIM VCTs invest mainly in companies listed, or about to list, on the AIM market. Finally, specialist VCTs focus on a specialist sectors, such as infrastructure or biotechnology, though the fact that they are less diverse can make them higher risk.

“VCTs are an exciting and dynamic area to invest in, with the potential opportunity to outperform the wider stock market,” said Emma Wall, head of platform investments at Hargreaves Lansdown (HL.L).

Investors buying new shares in a VCT are eligible for 30% income tax relief on their investment, providing they hold onto them for at least five years. That means if someone buys £10,000 of shares, when they file their tax return, they would be eligible to get £3,000 of tax back.

There is also no tax on dividends from VCTs and no capital gains tax on your holding if held for at least five years.

“VCTs are typically used by those investors who may have used their ISA and pension allowances and have larger portfolios, and the appetite for higher-risk investments,” said Wall.

“As the companies VCTs invest in are often new, very small companies which have a higher likelihood of failure, they are higher-risk investments,” she said. “They’re therefore aimed at more experienced investors with a detailed understanding of investments, who can afford to take a long-term view.”

Wall said that Hargreaves Lansdown recommends that VCTs are held as a smaller part — under 10% — of a large (over £100,000) diversified portfolio.

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Investors also need to be prepared to hold onto shares for at least five years, otherwise they will have to repay HMRC any any upfront tax relief they have received.

Jason Hollands, managing director at wealth management firm Evelyn Partners, told Yahoo Finance UK that this is an “important consideration because if you suddenly need your money … there’ll be consequences of doing that so it would be unwise to and no one does it unless they’re really desperate.”

VCTs will issue shares at launch, or will periodically issue more new shares, to raise funds. Purchasing new shares allows investors to benefit from the 30% income tax relief.

Wall said that investors should “read the prospectus for any new offer carefully as this will contain the specific risks for that VCT”.

“VCT managers may also from time to time provide buybacks, where they buy shares from existing investors,” she added. “This is often at a small discount to the value of the shares.”

Given that shares are traded on the LSE, they can be bought like normal shares. “But as even the largest VCTs are quite small, they can be illiquid as there are not many buyers and sellers,” said Wall. “This means it’s often difficult to buy and sell shares on the stock exchange and the price to buy and sell may be higher or lower than the value of the underlying investments. It may even be difficult to find a price at all in some cases.”

Investing this way in a secondary market, given the shares have already been owned, is not eligible for that 30% upfront income tax relief but investors will still benefit from tax-free dividends and growth.

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The minimum amount needed to invest varies for different VCTs, though it normally around £5,000, while the maximum is £200,000 per tax year.

VCTs tend to charge higher fees than typical investment trusts and funds. The initial charge can be as much as 5%, while annual management fees can be in the range of 2% to 3%. In addition, a performance fee may also be charged if the VCT performs well.

When it comes to eventually selling VCT shares, Hollands said that it would be unwise to do this by simply “hitting a sell button” online.

“Most VCTs these days are very good at managing their discounts by having regular buybacks so you really want to be selling your shares through a broker who can speak to the market maker and make sure that you’re selling them as part of a regular buyback so that you’re not selling at a big discount,” he explained.

VCTs have a net asset value (NAV), which represents the value of the underlying investments and is provided by the trust’s board of directors, typically twice a year.

“As the investments are not always listed on a stock exchange, this means that the value may be estimated using set valuation methods,” said Wall. “These are, however, estimates and the price you get for selling VCTs could be higher or lower than the net asset value.”

When trying to gauge their performance, one metric to refer to is the NAV total return, which is the NAV plus any dividends that have been paid over a period.

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The VCT’s annual dividend yield is another measure of performance to consider, which comes from dividing the dividends paid each year by the NAV.

“You might think that VCTs are actually all about building up capital gain and seeing the share price rise,” said Hollands. “In fact that’s not the case for … nearly all VCTs… the way they will prioritise generating return for shareholders is actually to pay out tax-free dividends.”

“It’s an important thing to understand because if you look at the share price returns of most VCTs, you’d think that they’re very disappointing – you have to look at the dividend payouts,” he added.

Hollands pointed out that VCTs “tend to be very careful about making sure they only raise money that they think they’ve got a home for and so they come … essentially periodically and will generally do a sort of new fundraising offer.”

He explained that this used to happen towards the end of the tax year but fundraising now starts in earnest around September because more of the main government budgets tend to be delivered in autumn. So VCTs are aiming to raise money ahead of the autumn budget, just in case any changes are announced, he said. As a result, the VCT season now tends to run from September to the end of the tax year.

Another key factor to understand is that VCTs will announce a target amount when they come to fundraising and they might state that the share offer will close at a certain date. Hollands said that the in-demand VCT share offers can fill up quite quickly.

“So it’s really important to be aware of your choices depend on who’s around raising money at the moment and do check as to how full they are before you pop a cheque in the post,” he said. “The good news is, in recent years many more VCTs are now allowing an online process — it all used to be paper based.”

The Wealth Club shared an example as to what a portfolio might look like for a first-time VCT investor, based on an investment of £35,000 split across four different VCTs — £10,000 in Albion VCTs, £10,000 in Baronsmead VCTs, £10,000 Pembroke VCT and £5,000 in Triple Point Venture VCT.

Nicholas Hyett, investment manager at the Wealth Club, said: “Picking just four VCTs can give you an underlying portfolio of a hundred of companies or more. By spreading your investment across multiple VCTs, you diversify the type of companies you back too — since different VCT managers tend to have expertise in different sectors.

“For example, the manger of Pembroke VCT has particular expertise in more consumer exposed investments, whereas the Albion VCTs have enjoyed particular success in B2B software businesses. The smaller Triple Point Venture VCT specialises in backing companies at an earlier stage in their development — where the risks might be higher but the potential upside is also all the greater.”

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