Baronsmead Venture Trust: My Problem Child

In a year of surging share prices, one of my holdings, Baronsmead Venture Trust, has been a real party pooper. But is it just a blip or an early sign that venture capital trusts (VCTs) have seen their best years?

Like many folks, I was first attracted to VCTs by the tax relief you get when subscribing to a new offer. It was March 2005 and the relief for that tax year had been increased from 20% to 40%.

I wasn’t the only muppet one. The total amount subscribed to VCTs leapt from £70m the year before to £520m.

The year after it was £780m, which was the last year 40% tax relief was available — it’s been 30% ever since.

Note that you only get this tax relief if you subscribe to new VCT shares via a specific fundraising offer — you don’t get it if you simply buy existing shares on the open market.

Sticking with the old guard

My money went into Baronsmead VCT. It was one of the first VCTs to be launched in 1995 after the legislation creating this curious investment vehicle was passed.

I’ve subscribed six more times since and not sold any to date. Under VCT rules, to keep the tax relief, you can’t sell any new shares until five years have passed. Some folks sell at this point and recycle the cash back into a new offer, to get further tax relief.

Any dividends you get are tax-free. There is no capital gain when you sell, although I believe most VCTs pay out all their profits as dividends, so it’s fairly rare for these shares to trade above the price you first bought in at.

Baronsmead had five VCTs back when I first invested and was flying high having sold its stake in fashion retailer Fat Face for 11 times its original stake.

The five were merged into two companies in 2016, with my holding converted into Baronsmead Venture Trust (formerly Baronsmead VCT 2).

And then, in late 2018, Livingbridge, the company that was managing the Baronsmead VCTs, sold its fund management business to Gresham House Asset Management.

The Baronsmead branding has been kept throughout the last 25 years, despite a few changes in ownership, such is its perceived strength in the VCT market.

Key stats for Baronsmead Venture Trust

• Listed: 1995 and 1998 (two funds merged in 2016)
• Manager: Gresham House
• Ticker: BVT
• Recent price: 73.25p
• 10-year net asset return: +116%
• Indicated spread: 72.5p-74p (2.0%)
• Exchange market size: 1,500
• Market cap: £157m
• Discount to net assets: 5.0% (77.1p NAV as of 30 Nov 2019)
• Costs: 2.2% OCF, 2.6% KID
• Gearing: None, 17% cash as of 30 Sep 19
• Historical dividend and yield: 6.5p  / 8.9% (but new policy just introduced aiming for a 7% yield)
• Year-end: 30 September
• Results released: May (interim) and Nov (finals)
• Sector: Venture Capital Trust: Generalist
• Wind-up vote: Continuation vote at each AGM
• Links: Website and AIC page

The rules they are a-changin

In 2015, the rules governing the sort of companies VCTs can invest in were shaken up. Whereas before, more mature and less risky businesses were allowed, now the vast majority of new money has to be put into much younger companies.

Some VCTs already fished in this pond, but Baronsmead was at the less risky end of the spectrum — which was a large part of the reason I invested in it.

It will take a while for this change to fully work its way through a VCT’s portfolio. Investments made under the old rules could take several years to exit.

Only about a third of Baronsmead Venture Trust’s investments are less than five years old and the average works out at around seven years.

Many veteran VCT investors seem to be dialling back their holdings in the sector until there’s some evidence of that returns under these new rules look satisfactory.

I last invested in February 2019, after a fair amount of deliberation, but reckoned that would be my last VCT investment for a while.

The Staffline saga

Up until the latter stages of 2018, all seemed to be going well. The market falls in the last quarter hit the net asset value of Baronsmead pretty hard, though.

It has slipped from 91.4p in September 2018 to 77.1p in November 2019, although 7.5p of that drop is due to dividend payments.

To date in 2019, the share price return is minus 1%. Go back three years and the total return is a pitiful 10%. Both these seem to be about ten percentage points lower than the sector as a whole.

Despite this, the 10-year share-price performance is still reasonable, with a gain of 140% that’s broadly equivalent to the sector average (although part of this is due to the discount narrowing).

Baronsmead’s largest holding, Staffline, has had a torrid 2019 with delayed accounts, accounting issues, and plunging profits — its share price has gone from £12 to £1.

At the end of 2018, Staffline accounted for around 6% of Baronsmead’s net asset value. It was the largest single company holding with Baronsmead and one the largest holdings in LF Gresham House Micro Cap Fund, which accounted for about 17% of Baronsmead’s assets.

Not the only bad apple

Baronsmead’s results for the year to 30 September 2019 made for gruesome reading:

Asset class	NAV (£m)	NAV %	Companies	Return
Unquoted	42	28	28	+11%
AIM-traded companies	54	36	54	-25%
Micro-Cap Fund	26	17	45	-7%
Multi-Cap Income Fund	3	2	42	+1%
Cash	26	17	n/a	n/a
Total	151	100	169	-10%

Even without the Staffline effect, the AIM-traded companies were down 16%. Holdings in Inspired Energy, Netcall, Dods Group, and LoopUp all saw decreases of more than £1m.

Brexit delays and concerns have hit the share price of many AIM companies and there are also people pointing to the Woodford saga as resulting in far less liquidity across this sector of the market.

The unquoted part of the portfolio has performed a lot better, though, which is encouraging given that this is likely to become increasingly important over the next several years.

Admittedly, most of the gains could be attributed to increased values at just two companies — Carousel Logistics and Custom Materials — and unquoted valuations are always more subjective than listed investments.

The Micro-Cap and Multi-Cap funds also struggled this past year. Apart from Staffline, I think the only other significant shared holding with Baronsmead’s direct investments is Inspired Energy.

These funds have done well historically, though. The Micro-Cap Fund is up around 330% over the last decade. The Multi-Cap Fund was only launched in June 2017 but it is up 21% since then putting it at the top of the UK Equity Income sector (not a great performing sector in recent years of course).

The Micro-Cap Fund is largely invested in AIM companies, the Multi-Cap Fund much less so. On a look-through basis, I reckon just over half of Baronsmead’s portfolio consists of AIM-quoted firms.

It’s worth noting that for the majority of the directly held AIM positions, Gresham House owns 5% or more of the shares in issue. And in about a fifth of holdings, it owns more than 10%.

In the case of Wey Education, for example, Baronsmead Venture Trust owns 9% and Gresham House’s combined funds own 20%. That might make it tricky for it to exit individual positions without seeing the share price slide.

Recent investments

Baronsmead invested £13.6m in 13 new and 7 follow-on holdings last year. That was a pick up in pace from the last 3 years, which have averaged around £6m.

The four sectors it focuses on are:

• Business Services
• Consumer Markets
• Healthcare & Education
• Technology, Media & Telecommunications

There is a research-heavy process to identifying potential investments using its extensive network of contacts to build up a relationship before investing.

Typically, Baronsmead has been investing about twice as much in unquoted business compared to AIM-quoted companies these past few years, so you’d expect the asset mix to slowly shift more and more towards unquoteds.

Divestments came to £20m last year, so there was still a significant cash balance of £26m at the year-end.

Baronsmead is currently raising up to £50m of new funds spread across its two VCTs. After several weeks, it’s only managed to get £20m.

Fundraisings in previous years have been snapped up within their first few days, although they were smaller in size. It seems I am not the only person taking a wait-and-see approach here.

The move to Gresham House

Although the downturn in Baronsmead’s fortunes happened around the time the business moved to Gresham House, there’s doesn’t seem to be a direct connection between the two. The investments that have struggled were made long beforehand.

Most of the Livingbridge team appears to have moved over with partners Andrew Garside (with Baronsmead since 2004) and Sheenagh Egan (since 1997) staying on as consultants.

Reviews from VCT specialists Tax Efficient Review and Allenbridge both seem to think the transition has been pretty smooth, with the team now having additional resources at its disposal from the larger Gresham House operation.

I’m keeping an eye on any staff turnover, though. Bevan Duncan, head of portfolio management, and chairman Peter Lawrence seem to be key individuals.

A dividend drop

Baronsmead’s VCTs have typically targetted a minimum dividend based in pence each year. It’s been 6.5p for several years now, 5.5p prior to that, and 4.5p before that.

For a while, there was also a target to maintain a net asset value of at least 100p but seems to have been ditched during the financial crisis of 2008-9.

Although it’s not guaranteed, I think the minimum dividend level has been achieved every year since being adopted although the merger of the two original Baronsmead trust makes direct comparisons a little fiddly.

Dividends have averaged since 7.5p since 1999 and have exceeded 10p on five occasions. The largest was 18.5p in the year to September 2016.

However, in September 2019, a new policy of 7% of opening net asset value was adopted.

September 2019’s net asset value was 75.1p so that suggests a target of 5.25p for the year to September 2020. However, that value does include a 3.5p dividend due to be paid in March 2020, so adjusting for that would indicate a lower level of 5.0p. A little clarity from Baronsmead would be welcome here.

There was a dual justification given for the policy change:

• The first reason was that the increased size of the company meant the absolute level was getting too high, which seemed pretty spurious to me.
• The second was that the increased proportion of earlier stage investments makes future disposals more variable, which seemed more plausible.

The net asset value needs to get back up to 93p for the new 7% target to equal the old 6.5p version. That seems a bit of stretch right now but maybe not too unreasonable on, say, a 3-year basis.

Some good news: decent discount control

One positive aspect of the last few years is that the share buyback programme employed by Baronsmead. It has kept the discount to net asset value fairly consistently around the 5% level.

About a decade ago, the discount was around 10%.

Around 9m shares have been bought back over the past two years and the last five trades recorded were for between 10,500 and 19,000 shares.

It’s not a complete lobster pot, therefore, which is something that can happen with smaller VCTs.

Charges that grate

A big issue many people have with VCTs is the high level of charges. And with good reason.

One factor is that most VCTs are pretty small. There are around 80 in total but their combined assets are just £4.6bn. That’s just £60m on average.

With £8.5bn of assets, Scottish Mortgage alone is almost twice the size of the entire VCT industry!

Only nine VCTs have an ongoing charge of less than 2% and the weighted average works out at 2.5%.

Baronsmead, at 2.2%, is cheaper than most. But for a fund with over £150m in assets, it looks pretty expensive, especially when you consider that many of its holdings are duplicated by the £175m Baronsmead Second Venture Trust.

The basic management fee is 2% but there is also a performance fee of 10% over the higher of 4% or base rate plus 2%. Baronsmead Second Venture Trust is 2.5% basic plus a 10% performance fee over 8% — I’m not sure why it’s the more expensive of the two.

I don’t think these charges have been reduced in some time — that’s very disappointing given the increase in fund size and the progress made by the wider investment trust industry. I suspect there will be pressure on fees should its performance not pick up fairly soon.

You would have thought that the recent announcement regarding the dividend cut would have been a good time to make such a change!

Summing up

I’m reluctant to cut a position loose based on one bad year out of twenty. Including the tax relief, I’m up 15% plus all the dividends I have received over the years.

My options are limited by the fact I can only sell just over half my holding right now without losing some the tax relief granted on the way in. It will be three years before I can pretty much sell all of it.

In hindsight, I probably should have spread my VCT investments over a few different managers. That’s a fairly typical approach to VCT investing, but Baronsmead accounts for less than 3% of my portfolio and I was a little reluctant to spread myself too thinly.

Standard advice seems to be to have a maximum of 10-15% of your portfolio in VCTs, due to their high-risk nature, but I’m well below that level.

I’m a little disappointed in the dividend cut but it makes sense to provide a bit more flexibility here. It could be that the average payout continues at roughly the same level, but it will be a while before this can be assessed.

Baronsmead’s costs are something that do need addressing, especially as there’s a fairly large cash balance and the management fee is charged on that as well.

I’m hoping that the AIM-quoted companies can bounce back a little when the immediate headwinds clear a little. And I’ll be keeping an eye on the valuation changes for recent unquoted investments plus the performance of Baronsmead relative to the rest of the sector.

I may sell down part of my position in a couple of years if there’s no noticeable sign of improvement but it feels a little premature to pull the trigger right now.

   

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Disclaimer

Please note that I may own some of the investments mentioned above -- you can see my current holdings on my portfolio page.

Nothing on this website should be regarded as a buy or sell recommendation as I'm just a random person writing a blog in his spare time and I am not authorised to give financial advice. Always do your own research and seek financial advice if necessary!

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