Markets in Freefall, Chinese shares and VCT Issues

While the world seems to be collapsing around us – with sharp falls in the price of most commodities including the critical ones of oil and gold – this writer took the time to attend the Annual General Meeting of Downing ONE VCT this morning. Forget also the fact that the Chinese stock market plummeted yesterday. The more I read about the dynamics of that market the more it looks similar to the US market in the 1920s where manipulation was rife, many investors bought on margin and bucket shops exploited unsophisticated retail investors. The interventions by the state to stabilise the market may be to no avail because they have created an unstable and volatile market where investors are borrowing money to buy shares without any real understanding of why they are doing so except that prices are going up.

I may do a longer piece on the problems in the Chinese stock market in the future as it’s passed by a lot of UK investors, but today I wish to talk again on something of more immediate concern to UK investors. This is the impact of the new VCT rules announced in the Budget. The AGM at Downing One VCT enabled me to ask some more questions on this topic, and here is an extract from the report of the meeting which is present on the ShareSoc Members Network:

The meeting was opened by Chairman Chris Kay, who just happens to manage the very successful Chrysalis VCT. He introduced the board and representatives from the fund manager including Nick Lewis, Senior Partner, who I have met many times before and who is very knowledgeable on the issues affecting VCTs.

Mr Lewis was then invited to explain the proposed changes to VCT regulations which will affect what they can invest in. See this ShareSoc blog post for a brief summary:

Mr Lewis indicated that it might create some difficulties with “buy and build” strategies – for example if a pub chain wished to add another pub and finance it via a VCT investment. The reason for the rule tightening is that the previous regulations were seen as breaching EU imposed rules on state aid limitations. The new rules are likely to be approved in September by Parliament with Royal Assent in October.

I asked how many of the investments made by Downing in the last year or two would have been ruled out by the new regulations. The answer given was less than 50% but other VCTs might be more affected (the Northern ones were mentioned later as they do a lot of MBOs which are made difficult by the new rules and Northern have already suspended their dividend reinvestment scheme, presumably as a consequence).

Asked whether representations had been made on the new rules (i.e. to the Government) and the answer was yes but they had apparently “fallen on deaf ears”. The conclusion was that it might definitely shrink the VCT industry with few fund raisings. This change has been imposed by the EU which prompted Nick to say that this is the result of being run by Eurocrats and you will get your chance to get out next year – so we know which way he might vote on any Brexit referendum.

I asked whether it would rule out most AIM investments, and the Chairman said Yes in summary. But they can do follow-on investments if the VCT invested in the company earlier. However the exact rules were very unclear and opaque. Questions to the Treasury about how they are supposed to be interpreted result in confusing answers. Moreover apparently any breach of the rules (even inadvertent ones such as happened at the Oxford Tech VCTs) might result in the loss of VCT status. This would be a nightmare for VCT managers and VCT investors as the rules are already so complex that they take a lot of effort to adhere to.

Is there an easy way around the new rules? Not obviously was the answer.

It seems likely the demand for new VCT share issues will exceed the supply in future. However that might reinvigorate the “second-hand” VCT market.

So there you have it. I have written to my M.P. on the subject of the rule changes. It makes sensible financial planning by VCT investors and VCT company managers very difficult when the Government keeps changing the rules. VCTs have been very successful in stimulating more investment in SMEs and meeting the UK “equity funding gap” as it is called. They are in danger of being stifled by the EU.

After the problems in the Eurozone over Greece, where the solution settled upon does not really resolve the issue of the country having an unsupportable level of debt, it is certainly undermining my personal support for membership of the EU. In Greece they just gave a bad debtor more rope to hang themselves with. Some write-off of debt will surely have to happen sooner or later, and in the meantime the Greeks will just squirm and try to wheedle their way out of their straitjacket.

One could go on at length on the deficiencies in the EU in terms of democratic representation and their ham fisted approach to many matters (Shareholder Rights and the Prospectus Directive are other examples) and the faults in the Eurozone model but that will have to suffice for the present.

Roger Lawson

FT Acquisition, Toshiba, Diageo, Healthcare Locums, False Accounting, Chinese Companies, and AIM

The Financial Times is being sold by Pearson to Japanese media group Nikkei Group. The Chairman of Nikkei was quoted as saying it will be “business as usual” (in the FT of course) and that the “philosophy and values of the FT are the same as ours”. Clearly they are still in the honeymoon period but let us hope that is true as the FT provides excellent factual news and commentary in general. Here’s just some of the news they have covered recently that is worth highlighting.

Toshiba. Perhaps we will get more coverage in future on Japanese companies. The latest big news story was the resignation of the CEO of Toshiba over accounts that falsely inflated profits by US$ 1.2 billion over the last seven years. This follows a similar problem at Olympus, another major Japanese corporation, in 2011.

Diageo. But if you think this is a peculiarly Japanese problem, think again. Another FT report on 25/7/2015 was on UK company Diageo who are being investigated by the SEC for “channel stuffing”. In other words, encouraging distributors to take more stock than they need thus inflating reported sales figures. Why would distributors do this? Because the supplier promises they won’t have to pay for them any time soon, or provides for cancellation/return options, or otherwise finesses accounting rules. We will see in due course whether this applies to Diageo.

Healthcare Locums. The former CFO of Healthcare Locums, Diane Jarvis, was fined £25,000 by the Financial Reporting Council (FRC) and recommended for exclusion from her professional accounting body for ten years. Healthcare Locums was an AIM listed staffing company which had to restate their accounts in 2011. Indeed it was commented on in the very first edition of the ShareSoc Informer Newsletter in February 2011 and was the first of many such reports on dubious AIM stocks that were favourites of investors for a while but then fell back to earth. This is what we said in that first edition: “Let us hope that this does not turn into another AIM debacle related to accounting as has happened in a number of AIM companies. Torex Retail was one example, but another outrageous case was Aero Inventory”. Silverdell and Quindell were later examples. Our hopes for Healthcare Locums were misplaced and it later became apparent that the accounts were in essence false. The FRC simply said that Ms Jarvis “dishonestly manipulated” the accounts to increase the company’s apparent profitability. Among other things she allocated staff costs to reorganisation costs and over-capitalised staff costs.

The fine may seem derisory to investors who lost most of their money on this stock (the listing was suspended and the business later sold at a low valuation), but it seems Ms Jarvis did apparently co-operate with the investigation and “demonstrated contrition”.

Some investors might consider the former CEO Kate Bleasdale might be partly to blame for these events, although she claimed to have reported the accounting irregularities to the board. The new board denied that. Ms Bleasdale and her husband were declared bankrupt in May this year after running up large legal costs, partly on losing law suits.

Gate Ventures. A good example of excellent reporting by the FT was on the 24th July when they ran an article on Chinese company Gate Ventures. This was an AIM listed company which listed in March and by June its market valuation had surged by 1,500 per cent as Chinese investors allegedly piled in making it apparently one of the most successful AIM listings. But it seemed to be primarily a cash shell (£3m backing) with its only significant asset being UK rights to a musical called “Being Woody Allen”. The Nomad recently resigned and the shares have now been delisted as the company said they could not find another Nomad in time to meet the regulations (market cap nominally £103m at the time of suspension). Just reading the article would put you off most investors from ever buying shares in the company.

The FT has done a great job of highlighting the problems of AIM and Chinese companies listed thereon in particular. For example, they report in the article that 3,000 companies have joined AIM but 2,160 have never produced a return. They quote Colin McLean of SVM Asset Management as saying “AIM may not be the only market to lose money, but few have parties to celebrate it“. Presumably he was referring to the recent 20-year anniversary of the launch of AIM. He also criticised the light regulation of AIM.

ShareSoc has published many articles in the past on AIM and its deficiencies. Although some investors only have themselves to blame for over enthusiasm about early stage companies, the regulatory structure of AIM is a substantial problem. In addition the kind of companies that are encouraged to list on AIM seem to be run by characters who often have odd or inappropriate backgrounds (Gate Ventures Executive Chairman had a past successful career as a songwriter for Elvis Presley, et al, you will be amused to hear). The investors who control the company are also often dubious – for example in Gate Ventures a handful of British Virgin Islands registered companies. The key problems with AIM are that the LSE makes money out of listings, and seems to have little regard to the quality of the businesses that list. They rely on Nomads, who are paid by the companies, to do due diligence and undertake the regulatory role. In addition Nomads often act as the company’s broker so there are obvious conflicts of interest there. A self-regulating market has always proved to result in weak regulation – the main LSE market was changed in that regards many years ago.

ShareSoc would certainly like to see a tighter and different regulatory regime on AIM, which might ensure there were less accounting scandals and corporate governance issues. Unfortunately some investors and many company promoters seem to like the “free for all” that epitomises AIM at present.

Roger Lawson

Alliance Trust Results

Yesterday (23/7/2015) Alliance Trust (ATST) announced its results for the six months to 30 June 2015. The results were disappointing with a net asset value (NAV) total return of 1.4% and a share price total return of 2.7%. Based on data published by Morningstar the NAV and share price total returns were below comparable figures for the company’s peer group. The Morningstar peer group NAV return was 4.26% and share price return 5.53%. The Alliance Trust discount has, however, fallen from 12.4% at the end of December to 11.2% at the end of June.

As usual, the announcement tries to place a positive gloss on the results, highlighting the out-performance of the equity team since it took over responsibility for the portfolio in September 2014. The new team have been concentrating the portfolio with the number of holdings coming down from 88 to 68 over the past year. There is now a heavy emphasis on Financials, Information Technology and Health Care in the portfolio holdings.

Assets under management in Alliance Trust Savings (ATS) increased but the business again made an operating loss in the first half, excluding the costs of the acquisition of Stocktrade. Overall loss including those costs was £1.1 million.

Alliance Trust Investments also lost money although the losses were reduced to £1.1 million.

Having digested the feedback from shareholders in the run up to the AGM last April, the Board is planning to make an announcement, in the Autumn, of the changes it intends to make but gives no indication as to what these changes might be. The interim results announcement also states that the Board’s search for a third new non-executive director is progressing well.

Comment: The poor investment performance, the continuing losses in the subsidiary operations, and the more concentrated investment portfolio may not impress long standing investors in Alliance Trust. Anyone who holds shares in Alliance Trust should register their interest in the ShareSoc campaign on this company – see

Roger Lawson

National Grid AGM, Rensburg AIM VCT and Stocktrade

I attended the National Grid Annual General Meeting in Birmingham yesterday. Unfortunately I was not allowed to ask a question as the organisation that I was representing as a proxy put my son’s name on it rather than mine so I was only allowed in as a “guest”. I will do a fuller report on the event for the ShareSoc Members’ Network later today, but it was not a particularly exciting event this year. Not a single shareholder complained about the outrageously high pay of the executive directors. The Chairman was both dogmatic and condescending to the mainly private shareholders who attended – he could certainly do with some advice on how to handle such meetings. His boring presentation was read out from a script, and contained not a single joke to lighten the event so far as I recall. But I did learn some useful information.

Rensburg AIM VCT

I was on my way to Birmingham when I learned that the Rensburg AIM VCT AGM scheduled for today (the 22nd July) had been cancelled. In the RNS announcement’s wording it had been “adjourned” until the 25th August. So I had to change my travel plans at some inconvenience. Other shareholders might likewise have been affected, if they even knew about the change. It’s all very unusual and unreasonable to cancel an AGM at the last possible moment and is usually done only when circumstances absolutely dictate it. So for example, the Maven Income & Growth VCT AGM was not cancelled earlier this month even though travel difficulties due to a tube strike in London on the day were immense – and the directors all turned up. This reinforces my view that shareholders should vote against the directors of Rensburg AIM VCT as previously recommended. See this note for more comments:

Stocktrade and Personal Crest Membership

One thing I did learn from the National Grid AGM was that Stocktrade are to definitely cease supporting Personal Crest Membership following the takeover by Alliance Trust Savings. Representatives of Stocktrade were at the meeting and I was told that such investors will be advised very soon that they will have to move into a nominee account or depart. I will definitely be departing in that case. The grounds given were the extra administrative cost of Personal Crest accounts which I believe is false. In any case, if that was so why not simply charge more for them? I have already made representations on this matter and will do so again. It is exceedingly annoying that many stockbrokers are now positively moving to withdraw support of Personal Crest membership. Such accounts are a very good way to ensure you get all your rights as a shareholder. There was an article on the benefits of such accounts in the June ShareSoc Newsletter and I will certainly be looking for another stockbroker who does support them as a priority. If anyone wishes to make representations on this matter to Alliance Trust, Patrick Mill is the Managing Director of Alliance Trust Savings (ATS) – his address is Alliance Trust Savings Limited, PO Box 164, 8 West Marketgait, Dundee, DD1 9YP. Or send an email to . You may also care to copy Katherine Garrett-Cox who is the CEO of Alliance Trust and who also Chairs the ATS subsidiary, and also Mrs Karin Forseke who chairs Alliance Trust itself (the parent company).

Roger Lawson

VCT/EIS Changes and Rensburg AIM VCT

The Summer Budget announced changes to the qualifying investments for Venture Capital Trusts (VCTs) and EIS investments. Some of changes and their impact were not immediately apparent but have come to light since.

The rules will effectively be tightened to keep them focussed on early stage companies. For example for VCTs the investee companies will need to have been trading less than 10 years (or 7 years if they are not “knowledge intensive” businesses) and management buy-outs will be discouraged. The details of the new rules are given in a document entitled “Summer Budget 2015: Amendments to tax-advantaged venture capital schemes” and in the Government’s response to a public consultation on “Tax-advantaged venture capital schemes” which has just been published. Anyone with an interest in this area can find them on the internet. ShareSoc did respond to the original consultation and you can see our response on the “Consultations” page of our web site.

Some VCT managers have declared that the new rules will make it more difficult to find suitable investments. The Northern VCTs have immediately suspended operation of their Dividend Investment Scheme (“DRIS”) so they will cease issuing more shares and instead will be returning cash to investors. Surely a sign that they feel that the new rules are very prejudicial.

One particular disadvantage for private investors is a new rule that will effectively prevent them from taking up EIS shares in Open Offers if they have previously bought shares in the company. So for example, if you bought shares in an AIM company in the market and there is then an EIS qualifying Open Offer then you won’t be able to participate. ShareSoc is writing to the Treasury about this as it seems particularly prejudicial to private investors and it is not clear why such a rule is necessary.

We will continue to monitor developments in this area as it is of particular concern to private investors. The changes to dividend taxation in the Budget might favour investment in VCTs as their dividends are tax free. So for example Maven Income & Growth VCT on which we have recently published an AGM Report (available from the Members Network) paid a dividend equivalent to a yield of 9.3% last year which is even higher when grossed up at your marginal tax rate. But the new rules might make getting a good return from VCTs more difficult – and historically many of them were poor investments even after taking the tax reliefs into account.

Rensburg AIM VCT

This VCT has announced that they have agreed for Unicorn AIM VCT (UAV) to take over the assets of the company after a tender offer of approximately £5 million (about a third of the net assets) to existing shareholders. Shareholders who do not take up the tender offer will receive shares in Unicorn AIM VCT. The tender offer would enable those shareholders who wish to receive cash to exit, while those who wish to retain the tax benefits of holding VCT shares can accept the shares.

The new shares in UAV to be issued will be based on the relative net asset value of the two companies which is normal practice. UAV will be paying the costs of implementing the proposals, other than the tender offer costs and any termination payments due to fund manager Investec – which are not given and this may be a question to raise at the AGM this week as they could be substantial.

The directors of Rensburg AIM VCT seemed keen to obtain a merger with another AIM VCT after they did a U-turn on doing a wind-up. That may be an unwise decision now that the new VCT rules have been published because surely AIM VCTs, which focus on listed and hence larger companies, might find it particularly difficult in future – as Rensburg were already seeing in finding good new investments at reasonable prices. I will do a report on the AGM of this company later this week (on the 22nd).

Roger Lawson

Foresight 4 “C” Shareholders Object

Shareholders in the “C” fund of Foresight 4 VCT are unhappy with the conversion of their shares to Ordinary shares. These holders are former investors in the Acuity VCTs. They feel the conversion is being done on inequitable terms for the “C” shareholders.

Put at its simplest, C shareholders are aggrieved that free and surplus cash in the C fund has not been paid out to them as a dividend before conversion. A large portion of surplus cash within existing C shares could have been paid out at 100% of value but now is being converted into ordinary shares that trade at a 30% discount. Furthermore the recovery of this free cash will take years to be received via dividends on new Ordinaries. Not only will this money be subject to regular ongoing management fees and other VCT charges but will effectively incur performance fee charges of 15% as Ordinary share dividends whereas as the C shares were free of such a fee.

Furthermore most C shareholders are long suffering VCT holders of the failed Acuity VCTs and have been waiting patiently for a substantial exit for many years. Many are also prevented from selling for another two years if they participated in the 2012 enhanced buyback. However they are able to freely receive dividends and thus have again been disadvantaged.

The Chairman of Foresight 4 has stated that the level of cash in the C share portfolio is £5-6m which will be the same as the Ordinary share portfolio at the time of conversion. However since there are twice as many Ordinary shares (38.6m Ord shares vs 18.7m C shares both with roughly equal NAVs/share) it follows that a balanced (cash/equity) conversion should only have been done with half the proposed levels of C share cash.

At a minimum this suggests that an extra dividend of £2.75m on the 18.7m C shares could and should have been paid before conversion. This would represent another 15p/share and such an additional interim dividend should be declared and paid out before conversion to achieve a relative fairness between classes.

A group of investors in Foresight 4 have written to the Chairman of the company on this matter.

Anyone who holds the “C” shares of Foresight 4 should send an email to to register their interest.

Roger Lawson

The Budget – How Will It Affect Private Investors?

George Osborne announced the Government’s Budget yesterday (8/7/2015). These were the main changes that might affect individual investors:

– Personal income tax allowance will rise from £10,600 to £11,000 in 2016-17. The Higher Rate Threshold will increase to £42,385 in 2015-16 with further increases in subsequent years.

– Dividend taxation will be substantially changed. Dividend tax credits will be abolished and be replaced by a new Dividend Tax Allowance of £5,000 with tax rates on dividend income above that at 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers.

– Buy to Let investors will be hit by a reduction in the tax relief they obtain on mortgage costs. This will reduce to relief only at the basic rate of tax, but this change will be phased in over 4 years from April 2017.

– Buy to Let investors will also be affected by replacing the “Wear and Tear Allowance” which they can claim by only allowing them to claim for actual costs incurred.

– Inheritance tax on homes will be substantially reduced by introducing an additional nil-rate band effectively minimising tax on homes worth less than £1 million. But the basic nil-rate band of £325,000 will be frozen until April 2021.

– Non Domicile status will be removed for many people who currently claim it. For example those who have lived in the UK for many years or who were born in the UK. Inheritance tax rules applied to non-domiciles is also to be tightened.

– There will be a further attack on people who pay themselves via personal service companies in the form of dividends rather than via PAYE (the IR 35 rules) by tightening up those regulations and increasing enforcement. There will also be more efforts to collect tax from the “hidden economy” and more focus on the tax affairs of high net worth individuals and non compliance by wealthy people. Trusts, pension schemes and non-domiciled individuals will also be a particular focus.

– Pensions investment tax relief for high earners will be reduced further from April 2016 and the Government is to consult on wider reform of pensions tax relief – for example possibly changing it to more like the ISA arrangements where there is no up front tax relief but no tax when cash is later taken out of the pension.

– Corporation Tax will be reduced from 20% to 19% in 2017 and 18% in 2020. But companies will be required to pay it sooner. Capital Allowances will be fixed at £200,000 and there will be restrictions on reducing tax bills by the cost of “goodwill” on acquisitions.

– Bank levy will be reduced over time down to 0.1% in 2021, and restrict it to UK operations, but there will be an additional bank corporation tax surcharge of 8% from January 2016 (overall banks are still therefore expected to pay more in taxes).

– The National Minimum Wage will be replaced by a higher Living Wage for the over 25s. This will affect those who currently employ large numbers on the Minimum Wage.

– Insurance premium tax will be increased. It will rise to 9.5%.

– The Climate Change Levy exemption will be removed for “renewable” electricity generators.

– The Chancellor seems keen to improve productivity where the UK lags behind other countries and to reduce the over concentration of business activity in London, but the details of how these initiatives are to be taken forward are not particularly clear.

Some comments are as follows:

Dividend tax change. Few people understand the dividend tax credit system so this might be seen as a worthwhile simplification, but it will increase the Government’s tax take, particularly from wealthy investors, very substantially. For example it is forecast to raise over a billion pounds per year in tax!

The original reason for dividend tax credits was to avoid double taxation on the same profits. When both corporation tax and personal tax rates were high, profits made by a company could effectively be taxed twice – once within the company by corporation tax and then when the profits were distributed in dividends. It could result in very high combined rates. But tax rates are now lower, particularly corporation tax.

The new £5,000 allowance will mean the vast majority of individuals who receive dividends will not be adversely affected. However, those with substantial dividend income will be. For example, someone who receives £50,000 a year in dividend income may be £3,800 per year worse off!

This of course will be offset to some extent by the improved personal tax allowance and higher rate threshold. It might however reduce the attractiveness of high dividend paying stocks and encourage a focus on capital growth. Capital gains will be taxed at a lower rate. It might improve further the attractiveness of Venture Capital Trusts where dividends are tax free, or encourage companies to return cash to shareholders via tender offers or buy-backs rather than dividends.

Buy-To-Let Investors and Building Companies.  There has been criticism lately of the profits and generous tax position obtained by buy-to-let investors which have fuelled the growth of this sector in recent years. The tax allowances were because they were treated like businesses where interest on debt is allowed, but unlike private individuals where mortgage tax relief was abolished many years ago. The good profits to be made and the low cost of finance of late has encouraged the growth of this sector and also encouraged the building of new houses, which we are surely desperately in need of but also resulted in more renting and less owner occupation. For example according to the BPF in London in 2013, 61% of new home sales went to investors of various kinds rather than owner-occupiers. The tax relief granted on these mortgages was becoming a very substantial figure and there were concerns that the size of this lending was creating financial instability.  The Chancellors statement caused the prices of house builders to fall substantially  – for example Berkeley Group fell by 7% and Persimmon by 5% on the day although they recovered somewhat the following morning. It was even suggested that buy-to-let investors might seek to sell their properties in future thus affecting the housing market overall. On the other hand, it might encourage more investment in the stock market instead in future years – many people have been investing in buy-to-let as a “pension” because they have seen betters returns there than in other investment sectors but this was always a risky proposition. It would seem unlikely that the sector will change rapidly and other house buyers might pick up any slack as the main limitation on house builders activities are the problems of finding sites and getting planning permission. House builders may be helped by changes to the planning system also announced. How this will all work out in practice is not as yet clear.

Renewable energy subsidies. The changes here caused the share price of Drax to fall by 28% as it was estimated it would reduce their profits substantially. Other companies were similarly affected.

Corporation Tax and Living Wage. The reduction in Corporation Tax rates will clearly help investors. The impact of the higher Living Wage might affect some publicly quoted retailers but in fact they often pay more than the Minimum Wage already – it might be the smaller private businesses that are more affected. Increasing the minimum wage might actually encourage improvements in productivity – by encouraging businesses to replace manpower by machines. It may slightly reduce employment though but is not forecast to have a major impact. Other changes to “benefits” will encourage people to seek employment.

The above is an initial analysis of the impact of the Budget. I hope to add more in the next ShareSoc Members Newsletter.

Roger Lawson