Go on, take a chance and do the splits

Split capital investment trusts can bring high, if sometimes risky, returns for individuals who have a gift for mastering detail.
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Investment companies take perverse pleasure in baffling ordinary folk with obscure products, but they really pushed the boat out with split capital investment trusts. A shame, really, because they offer investors the possibility of attractive, if sometimes risky, returns.

Investment companies take perverse pleasure in baffling ordinary folk with obscure products, but they really pushed the boat out with split capital investment trusts. A shame, really, because they offer investors the possibility of attractive, if sometimes risky, returns.

Split caps - or splits as they are sometimes called - are a breed of investment trust. Investment trusts are companies quoted on the Stock Exchange which invest in the shares of other companies, providing a broad spread of managed investments.

Investment trusts have been around since the 19th century, but splits only arrived on the scene in the 1960s. They are rapidly growing in popularity, with more than 20 new launches in the past 18 months. They are offered by big-name fund managers such as Fleming, Framlington, Gartmore, Henderson, Jupiter and Schroder, plus some less well-known names. Recent launches include Aberdeen European Growth & Income Trust, launched in November.

Like investment trusts, splits run one portfolio of investments, but they issue several types of share designed to appeal to specific investors. Originally, there were two classes of share, income and capital - by concentrating exclusively on either capital or income, investors would potentially receive greater returns.

Splits now come in different share classes, the most common being zero dividend preference shares (aka zeros), income shares, ordinary income shares and capital shares. Splits have a fixed winding-up date, when the various returns are divvied up and paid to shareholders. The share classes are ranked on where they stand in the pecking order when it comes to receiving a payout, with zeros first in line and therefore the safest investment, and capital shares last and therefore most risky.

Mark Dampier, head of research at Hargreaves Lansdown, says: "After a difficult time performance has improved and you can get returns of between 8 and 10.5 per cent. With low interest rates this is an attractive return, and if rates fall further next year as many predict, it will look even better."

Zeros pay a fixed capital return at redemption but, as their name suggests, they pay no income. "You can avoid paying tax on your returns using your £7,200 capital gains tax allowance. A higher-rate taxpayer paying tax on large sums of money sitting in a building society account will find that zeros have a lot to offer."

The Close FTSE 100 Trust-Zero tops the performance charts over the last 12 months, returning 11.55 per cent, say figures from Micropal. Returns typically hover between 6 and 8 per cent. Mr Dampier's preferred zeros are BFS Income & Growth, Jupiter Dividend & Growth and JZ Equity Partners-Zero. The other type of split Mr Dampier uses are frequently ordinary income shares. These offer a high income plus the chance to receive the surplus assets of the investment trust when it winds up, after other higher-priority share classes have been repaid (zeros, another type of share called stepped preference shares, and income shares are paid first). It is a relatively high-risk investment, and dividend and capital returns depend on the performance of the trust managers. "You can get returns of 8 to 9 per cent, and sometimes even 12 per cent, but a fund paying that much would be incredibly volatile," says Mr Dampier.

He says most investors should avoid individual ordinary income shares, and spread their risks by investing in a pooled fund. Hargreaves Lansdown runs its own fund, the HL Income & Growth Trust, for those who want to spread their bets. Legg Mason Utilities has topped the Micropal rankings for ordinary income shares over the last one, three and five years.

James Dalby, investment specialist at Bates Investment Services in Leeds, also prefers zeros and ordinary income shares, but warns: "Ordinary income shares offer the potential for income and capital growth, and can be used by mainstream investors to add oomph to their portfolio. But before recommending them to clients, I make sure they grasp the concept of investment trusts and the greater complexity of split caps."

Mr Dalby uses two other types of splits - income shares and capital shares, only rarely. Income shares offer the prospect of far higher yields than you could expect to receive from conventional shares, possibly with some capital growth when the trust winds up. "Some have offered income well into double figures, but there is no guarantee you will get your initial capital back at the winding-up date. With some you can get next to none of your capital back, which makes income shares more like an annuity," he says. His recommended income share is BFS Income & Growth. "I only recommend these for people who require high income immediately, as their initial capital is very much at risk."

Capital shares are last in line when the assets of the split are shared out, only receiving their entitlement after all other classes of shares have taken their fill. This makes them a high-risk investment, but since they are entitled to all remaining assets, if the trust performs well the capital return can be excellent.

For those interested in capital shares, Mr Dalby recommends Exeter Capital Growth, a unit trust that invests in the capital shares of investment trusts, with good recent performance.

But for Bhavesh Amlani, director of London-based financial advisers Simple Savings, splits are a risk too far. "Most people want something they understand, and they are put off by the complexity of splits."

Doing the splits may not be for everybody, but for more experienced investors, the rewards may be worth the risk.

Contacts: Hargreaves Lansdown 0117 900 9000; Bates Investment Services 0113 295 5955; Simple Savings 020 8863 4100

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