We all remember the ‘split-cap scandal’ of 2001-2003 that saw thousands of investors lose large amounts of money, but despite their chequered history, many experts believe split-capital investment trusts still have a place in investors’ portfolios.
Despite first being introduced in 1965, it wasn’t really until the 1990s that split-capital investment trusts became fashionable, promoted as the answer to every investor’s dream, offering the ability to concentrate on either capital growth or income, with the attraction of a predetermined return from zero-dividend preference shares as the icing on the cake.
Back to basics
The theory behind splits is a good one. They recognise that different investors want different things and offer each individual a tailored package – a pensioner may want a reliable income, whereas a younger investor will be more inclined to take risks to enhance returns.
Originally, the structure of split-capital investment trusts was simple. They had
a limited life with a fixed wind-up date and issued two classes of shares – income and capital. Investors who held income shares were entitled to all the income generated from the split during its life and the capital shareholders received the capital value of the investment company at wind-up.
Over the years, however, splits have evolved to offer a much wider range of structures and share types, each type of share with its own place in the order of entitlement at wind-up.
Annabel Brodie-Smith, communications director at the Association of Investment Companies (AIC), explains, ‘The advantages of splits are that they can provide for a range of investment needs, and if you want to invest for a fixed period, they can give
you a specific date for a potential capital payment. In addition, some share classes have no income associated with them, so there’s no income tax to pay.’
The batting order
At the top of the ‘food-chain’ there are zero-dividend preference shares – the first to be paid out when the company winds up. ‘Zeros’ are set up to deliver a capital return predetermined at launch. So if the investment company performs well, these shareholders will receive no more than the value set at the launch. However, if the company performs poorly, they may receive less than anticipated – or in some cases absolutely nothing.
Because the growth in the value of zeros is treated as a capital gain and not income, they are attractive to investors who want to avoid further income tax liabilities. Investors can, instead, utilise their capital gains tax limit – currently £9,600 for an individual each tax year.
Income shares are next in line; they provide shareholders with a regular return throughout the life of the split-capital trust in the form of dividends, which are generated from the underlying investments held within the company.
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