The risk's in the small print

Don't trust those dazzling adverts that promise high income returns.

Fund managers selling income trusts are always keen to stress the highest-possible rates of return in their advertisements. But often these dazzling "headline" rates conceal a host of less attractive features in the small print.

Fund managers selling income trusts are always keen to stress the highest-possible rates of return in their advertisements. But often these dazzling "headline" rates conceal a host of less attractive features in the small print.

Jupiter's new Dividend & Growth Trust, which closed its offer on Thursday, provides a convenient example. Advertisements for the fund dangle the carrot of 9 per cent income a year. At a time when even the best savings accounts are paying only about 6 per cent, that looks very tempting.

But Jason Hollands, of independent advisers BEST Investment, warns: "If something seems to be paying considerably higher levels of income than prevailing interest rates, it may be taking higher risks with the underlying investments. Or maybe they're doing something odd with the charges."

In this case, increased risk concerns Mr Hollands. The Jupiter fund is a split-capital investment trust. Trusts like these offer two different types of shares. One - known as a "zero-dividend share" - is designed for capital growth and the other for income.

The 9 per cent return promised by Jupiter Dividend & Growth comes from the trust's income shares. When the trust winds up in six years and the time comes to repay investors' capital, income shareholders will find themselves placed firmly at the bottom of the pecking order.

Philip Butt, director of Jupiter Unit Trust Managers, says: "When the trust is wound up, bank loans get repaid first, zeroes get repaid next and what's left over goes to the ordinary income shareholder."

Another characteristic of split-cap trusts is that they tend to be highly geared; that is, they borrow substantial sums to boost the funds they pull in direct from savers. The Dividend & Growth gearing lets Jupiter invest £100 for every £40 worth of income shares it sells. This has the effect of improving returns when the fund manager buys a good share, but increases his losses when he makes a mistake.

Mr Hollands says: "If you don't understand the split-capital structure, don't buy a split-capital fund." Mr Butt says: "It is absolutely true that people ought to be aware of the risks. In our literature, all these risks are spelt out in full."

Dazzling headline rates of interest would be far less common if potential investors were not so keen to take them at face value. David Hanratty, of Nelson Money Managers, believes savers have yet to adjust their expectations to meet the new environment of continuing low interest rates.

He says: "Nine percent is actually twice the going rate on a deposit investment. But it doesn't raise people's fears because 9 per cent is a rate they are familiar with from bygone years. People's income needs are so great they are swayed by the advertising. If their income is so important to live on they shouldn't take much risk." Mr Hollands thinks a better option is investment trust income shares that spread risk widely.

A "fund-of-funds"-style trust exists only to buy income shares in other investment trusts. Exeter Fund Managers' £120m High Income Unit Trust, holds shares in 50 split-capital investment trusts, and offers a yield of 7.96 per cent. Philip Thitchener, the marketing manager, says: "The fund manager puts together a portfolio that has some of the slightly more capital-risky income shares and some of the more capital-predictable ones.

"Exeter High Income appeals to those who have just entered retirement and perhaps don't have quite as much capital as would be ideal."

For a free copy of Investec Guinness Flight's Guide to Split Capital Investment Trusts, call 0171 597 1800