In times such as these, it is understandably difficult for some clients to
get excited about investing in the stockmarket. But falling interest rates
and ongoing negative comment on with-profits products mean that some of the
traditional alternatives to equity investment are not looking enormously
I would like to give a brief introduction to the attractions of another
product structure which to date has had fairly limited take-up in the
mainstream retail market – the split-capital investment trust. The
benefits of split funds are that they offer a variety of distinct
Split funds are listed and their shares traded on the London Stock
Exchange. Their name arises from the fact that their share capital is split
into a number of share classes. As a public company, information on the
structure and the rights accruing to different share classes is set down in
the prospectus at launch. Post-launch information about individual funds is
not only available from the relevant fund management company but also from
the Association of Investment Trust Companies and specialist information
Split funds normally have fixed lives of five to eight years. An example
of a typical structure would be as follows:
Zero-dividend preference shares
These offer a defined payback at maturity, typically equivalent to an
annualised return of 8 to 9 per cent. They are useful for clients looking
to accumulate a lump sum at a point in the future, for example, to pay a
child's university costs.
Zeros usually have first call on the assets when a fund is wound up. The
zero shareholder will see full payment of their predefined return before
any money is paid to other shareholders, making them the safest of all
These offer high income, typically between 7 to 9 per cent. Such an income
can be generated because all or substantially all income accrues to this
single share class. In return for this high dividend stream, investors
forgo most, if not all, capital growth. They also accept a measure of risk
since, if there is a shortfall in assets at maturity which cannot be
covered by the capital shares, then the capital returned to income
shareholders will be reduced.
These shares offer geared capital growth. They have no right to income but
will receive all the residual capital growth on the portfolio after the
predefined returns to the zero and income shareholders.
Capital shares are therefore the riskiest shares available within a split
fund but can generate significant growth if the underlying portfolio does
well. They may therefore be an attractive home for a small portion of a
client's portfolio if there is a belief that the underlying portfolio
offers good growth prospects.
That said, when deciding to invest in these shares, it should always be
remembered that any shortfall in assets at the maturity of a fund falls on
the capital shares, so caution is required.
It should be noted that by no means all split funds have the above share
class structure. A popular alternative has just two share classes – zeros
and ordinary shares, with the latter effectively being the amalgam of the
income and capital shares described above.
As well as the share capital of a fund being split, quite often the
investment portfolio is also split. Where this is the case, there will be a
core growth portfolio investing in equities and a smaller income portfolio
investing in bonds or the income shares of other split funds. This income
portfolio helps generate a higher yield than would be possible if the fund
restricted itself purely to equities.
The risk profiles of the individual share classes obviously vary but, when
selecting a particular fund, the risk of the fund in its entirety needs to
be assessed. There are two main areas to consider.
If the equity portfolio is invested in a high-risk area, this increases
the risk across all share classes, albeit to varying degrees. Within the
income portfolio, the holding of the income shares of other split funds
(rather than corporate bonds) also introduces risk.
Many split funds gear up their exposure to the underlying assets through
use of bank debt. While this is not necessarily a bad thing, if the debt
exposure is high, it can introduce too much risk, particularly when a high
debt level is coupled with a volatile underlying investment portfolio.
Split funds are not the simplest of products but they do offer some unique
features for investors looking to diversify the risk within their
portfolio. I believe it is worth the effort to get to understand and use