A DIY effort could produce better results at lower cost with greater flexibility and tax-efficiency, acccording to John Szymanowski, an investment trust specialist at SG Warburg Securities.
Most off-the-shelf investments guarantee either money back or a percentage of stock market gains, but they lock investors in for a set term and impose high penalties for cashing in early. They also pay for the guaranteed return by giving up part of any gain realised and probably all dividend income.
Mr Szymanowski's DIY plans have none of these disadvantages, providing relatively high income as well as a reasonable chance - although not a guarantee - of a full payback after five years.
As shown in the table, the plan is that investors buy a mix of investment trust income shares and zero-dividend shares. As their names imply, income shares pay dividends while zeros pay none but both are redeemed by the investment trust issuers at fixed prices on set dates. In the case of income shares, the amount payable on redemption may be negligible, such as the 0.lp per income share due from M&G Recovery in April 2002.
All the income shares shown in the table qualify for personal equity plans but, given the number of shares involved, investors would have to be careful to choose a PEP manager whose charges for reclaiming the tax automatically deducted from dividends would not wipe out the tax benefit.
The zero dividend shares cannot be held in PEPs, but any capital gain on sale or redemption should escape tax if set against the £6,000 annual capital gains tax exemption (assuming this fiscal break survives the political vicissitudes of the next few years).
Mr Szymanowski's plan assumes investors will sell all the investment trust shares in March 2000, and estimates the then prices of the income shares on the very conservative basis that they will not have produced any dividend growth by that time. Estimates of the March 2000 prices of the zeros also build in a wide safety margin.
At present, all three zeros in the table can already cover their redemption prices out of existing assets and still have somewhere between 9 per cent and 10 per cent to spare.
So if the assets of all three trusts declined by more than 1 per cent a year between now and the redemption dates, the trusts would still be able to meet their payouts on zeros. Mr Szymanowski said this would reassure investors planning to sell the zeros up to two years before the redemption is due.
"The cover is pretty reasonable," said Mr Szymanowski. "M&G Income is due to redeem at 102.6p in November 2001, but all we want from them in March 2000 is 89p. Gartmore Scotland's redemption price for July 2001 is 292.4p, and all we are looking for is 259p. Gartmore Shared (senior) is due to pay out 198.8p in April 2002, so our estimate of 162p by March 2000 is fairly conservative."
Interest rates will also influence the price of zeros. "If interest rates go up over the next five years, you may have to hold on a little beyond March 2000 to achieve those estimated prices," explained Mr Szymanowski. "But if interest rates were to fall, you could reach those prices much more quickly, and there is nothing to stop you cashing in early - there are no early redemption penalties or cancellation charges."
In contrast, a ready-made, guaranteed PEP soon to be launched by Scottish Amicable is to guarantee investors money back after five and a half years and a fixed income of probably 7 per cent from a new investment trust. But the company will pocket any capital or income in excess of the guaranteed return, while investors who cash in before mid-2001 will pay a £25 exit charge as well as forfeiting the full money-back guarantee.Reuse content