Scottish National is a split capital investment trust. This means the trust has ordinary shares as its main assets, mainly in big names such as BT and Lloyds TSB. But the fund managers then split up the shares they issue to investors, and usually offer three different types of shares (see box).
The big money-makers are the capital shares. Split-capital trusts have a fixed lifespan, and when you buy capital shares you are buying the chance to take a share of whatever capital is in the fund after the winding-up date. It sounds simple but there is (of course) a snag. "It's not out of the question that you could lose everything if there was a market upset," says Tim Cockerill, managing director of Whitechurch Securities, independent financial advisers. "Capital shares are quite complex, and they magnify the ups and downs of the stock market. You buy them if you believe the market will do well in the long term. But you have to accept that you may wake up and say `Oh my God' because they've gone down massively."
During the life of the investment trust, capital shares can be traded through stockbrokers like any other share. Scottish National, which is due to wind up in September, has seen the price of its capital shares rise 90 per cent in one year. There are currently enough funds in the trust to pay out 239p per capital share when the trust winds up in September. Any stock market growth between now and then should mean investors get a bigger payout. As the shares are trading at 219.5p each at the moment there isn't much to gain if the market does not move up between now and then. And if it falls dramatically, you could lose a lot of money.
If you are thinking of buying capital shares you should probably be taking a long-term view. Look for a trust with a winding-up date in several years' time - but don't expect to find bargains. Richard Hughes manages M&G's Recovery investment trust, winding up in 2002. He says capital shares in his fund were trading at 20p in September but are now around 70p each. Even so, there is enough money in the fund now to repay that amount to capital shareholders if the market doesn't move upwards between now and 2002. If the fund grows at 5 per cent a year, the capital shares will grow at 20 per cent a year. At 10 per cent growth a year, you'd get back 34 per cent growth from the capital shares.
This exaggerated performance is possible through "gearing" - borrowing against the assets in the fund in the hope of making more money. Investment trusts do this by selling loan stock. The more highly-geared a trust is, the more volatile the share price will be. "If they pile on the gearing and something goes wrong, it can be disastrous. A share may have put on 200 per cent in a year but there are no guarantees it will continue," warns Mr Cockerill. If you make short-term gains by buying capital shares, you may be happy to take the money and sell up when prices are high.
The biggest holdings in M&G's Recovery fund are Lloyds TSB, Royal & SunAlliance, BT, NatWest and Ocean Group - not obvious "recovery" stocks. Mr Hughes says: "Our definition of recovery is a company going through a difficult time - it may be a problem with a division or a subsidiary. Some shares we bought six years ago have recovered, but if there's more out-performance to come we hang on." Other managers look for firms outside the FT-SE 100 index.
Capital shareholders might be left empty-handed when the trust winds up if there's a market downturn or the underlying shares held in the trust perform badly. All the owners of lower-risk zero-dividend preference shares (see box) have to be paid off at their guaranteed price when the trust winds up. If there is anything left it is shared out among capital shareholders.
If you like the sound of capital shares but haven't the time (or the nerve) to invest directly, there is a unit trust that specialises in capital shares. The
Split capital investment trusts are a type of investment trust that has a fixed lifespan. All the assets are divided up between investors when the fund winds up. The shares bought and held within the fund are often big names like BT and Glaxo Wellcome. The complicated part is that the fund managers issue different types of shares. Most commonly, these are:
q Income shares pay an income during the life of the trust. Some have no value at the end of the term.
q Zero-dividend preference shares have a fixed redemption price, which is almost certain to be paid. Often used for school fees planning.
q Capital shares offer the chance of spectacular returns if the trust has done well. Effectively, capital shareholders get everything that is left at the wind-up date after the less risky classes of shares have been paid off. Capital shares (known as caps) are bought and sold during the life of the trust, and investors can make big gains without holding the shares for the full term. The downside is that you could lose all the money you invested if the stock market performs badly.
q The Association of Investment Trust Companies has a free factsheet on this type of trust: call 0171-431 5222.