Investment Trusts: Capital idea for income seekers

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The Independent Online
EVEN after the recent half point rise in base rates interest levels are little more than a third of the peak they reached in mid-1990. The result has been a flight from banks and building societies to investments which offer a higher yield. The highly flexible capital structure of investment trusts has given them a unique combination of tax efficiency and flexibility in generating the income that investors crave.

This is enhanced by the fact that many trusts will qualify for Personal Equity Plan (PEP) status so that the income can be paid tax free.

According to statistics from HSW, the investment trust in the High Income sector with the highest yield is the Dartmoor Investment Trust, which is managed by Exeter Asset Management. The gross income is currently more than 10 per cent, and is paid quarterly.

David Hackett, one of Exeter's fund managers, explains how Dartmoor achieves this. ' pounds 16m of the capital was raised as an index-linked debenture, repayable in 2005. With inflation low at present, the cost of this borrowing is well below the income it can generate, and the ordinary shares benefit from this excess income.'

The fund invests largely in the income shares of other split capital investment trusts. Although these provide a high level of income they offer little or no opportunity for growth. The fund balances this by some investments in capital shares from split capital trusts.

This combination is designed to ensure that the fund preserves the capital value of the investment. Although the capital shares may give some opportunity for capital growth, David Hackett confirms that the main emphasis is on generating income.

'We are looking to produce a high and growing level of income for investors. That has been a very difficult task in the past 18 months, because of the dividend cuts made by UK companies. This in turn has reduced the dividends coming from the income shares we invest in. However we seem to have reached the end of the cuts, and we are confident that the fund can go forward over the next 12 to 18 months with dividend growth.'

The index-linked debenture does mean that capital preservation depends inflation and of investment performance, but it cites independent statistics showing that growth of only 4.8 per cent a year is needed to repay the shares at their current levels in 2005.

Another high-yielding performer is Geared Income Investment Trust, managed by Broker Financial Services, based in Guildford. The yield is currently around 9 per cent. Tony Reid, a BFS director, explains that the fund effectively acts as a manager for those who want to invest in income shares of split capital trusts but find them too confusing to buy them directly. 'We use three different types of income shares. The traditional income share is currently yielding about 9-10 per cent and has a fixed repayment price based on little or no growth.

'The long-dated annuity shares are yielding about 17 per cent, but they will have little or no value at all on redemption. Finally, some split capital trusts have geared ordinary shares which offer a yield of around 11 per cent, but a volatile capital return because they are repaid after the zero coupon preference shares. The key is to get the mix right and adjust it as the market changes.'

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