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Split decision

How can you justify selling a product that has been the subject of an 18-month investigation by regulators? How do you convince a client that despite 194m compensation for investors, split caps are still a good deal?

These are some of the questions that IFAs are facing as they prepare to explain to clients what the future holds for split-capital investment trusts.

For two years, investors have heard horror stories of shareholders with zeros losing up to 95 per cent of their investment.

But the annual review from stockbroker Cazenove – using figures covering January-December 2003 – finds that split caps enjoyed a strong recovery, with many offering returns that outstripped the FTSE All Share index. Total returns on ordinary income shares in split-cap trusts rocketed by an average of 47 per cent while zeros shot up by 37 per cent. The FTSE All Share rose by 21 per cent over that period.

The move by the FSA, signing up 18 firms to a compensation scheme will do little to boost confidence.

Investors will still be left with questions over who is to blame since none of the firms involved in the deal was reprimanded or admitted any guilt.

Some firms were asked to undertake retraining of staff, redeployment and to give undertakings. Three people who were facing individual investigations had all regulatory action dropped against them. Former Aberdeen Asset Managers Christopher Fishwick was the only person named who was asked not to apply for FSA authorisation for seven years.

The FSA does seem to give a ray of hope though in its publication of lessons learned and reasons for the failures. But closer reading shows that, as an explanation for the collapse, investors are pointed towards September 11 and the fall in price of technology stocks, followed by attempts to remedy this by split managers undertaking new issues and cross-holdings of shares.

The FSA then goes on to urge firms not to conceal or create misleading information, to represent shareholders, manage conflicts of interest, highlight risks in fund information and give consideration to investors in fund manager and broker decision-making.

F&C Asset Management has tried to point out the fact that the split-cap market has been overlooked. Progressive growth fund manager Peter Hewitt believes a rehabilitation of the sector is on the way but it will take a lot more than a few positive words from a manager to persuade investors.

Hewitt argues that a portfolio of good-quality sensibly financed zeros that stick to what they promise to do while avoiding high borrowings and investments in other splits have the potential to produce impressive returns at a low level of risk.

High-quality zeros typically have a gross redemption yield of around 7 per cent, according to data from ABN Amro. At the end of October 2004, Jupiter had three splits that came to the end of their term while Gartmore Asset Management’s second Scottish National fund and the Murray emerging growth fund, managed by Aberdeen, were both wound up.

Hewitt says: “It is important to recognise that not all trusts in the split-cap sector have been affected by the specific problems of high bank debt and cross-holdings in similar trusts. The rollover options could yet prove to be a shot in the arm for the declining universe and they could be said to represent a new optimism for zeros.”

For many IFAs, any real opportunity for split caps in the retail arena could only come once straightforward investment trusts are fully back on the map. Even these are viewed as having an extra layer of complexity when compared with unit trusts and Oeics because of discounts, premiums and gearing.

Bates Investment Services head of investments James Dalby thinks the FSA’s new Coll regulations will enable investment companies to create some innovative, absolute-return, multi-manager, multi asset class funds.

Dalby says: “This will be the growth area and will probably be one of the factors that ensures the split-cap
market will not be rehabilitated for consumer purposes.”
He admits there may still be a market for splits with institutional investors but consumers are still wary.

The timing of the FSA’s statement of the resolution of the split cap scandal — at 1pm on Christmas Eve – was, claims the regulator, because of the market sensitivity of the information that was being released.

The dust has settled on the debacle. There is still the question of what will happen to the four firms and eight individuals – the exact identity of whom are unknown – that have not signed up to the deal.

It seems likely they will argue they were not to blame and should not have to pay compensation. Whatever happens, IFAs will be expecting a public explanation from those involved and the FSA.

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