Memorandum submitted by the Association
of Investment Trust Companies
When the AITC appeared before your committee
in the summer, I mentioned two initiatives that we were working
on. I am in a position to update you on each of these.
We have been engaged in a very significant project
whereby we have collected the complete portfolio lists of almost
every company in the universe of split capital or very highly
geared closed ended investment companies. This includes all those
funds that have invested in shares of other investment companies
(often themselves split capital or otherwise highly geared). We
collected this data at the end of March. As you can imagine this
was a fairly laborious process and the fact is that data has not
arrived in a standardised format making our data inputting a very
time consuming task.
Our primary ambition for this project was that
it would enable us to "net out" the impact of the sectors
cross holdings and identify the value of the "real"
assets underpinning shareholder value. We expected that this would
enable us to identify those funds most at risk of continuing falls.
We also hoped that this project would help the market to arrive
at better judgements about risk generally for splits.
In the event, we have still not yet completed
this project, although we hope that it will be a matter of days
rather than weeks. The construction of the spreadsheet and the
inputting of the last few funds have taken longer than expected.
Furthermore, the continuing falls in stock markets, in general,
and of split shares, in particular, has substantially reduced
the quantum of possible future losses as, in effect the vast majority
of the value that could be lost has already been lost.
Nonetheless, the project will still provide
valuable data and may well provide solutions to the provision
of robust risk measurement standardisation for the industry.
A second initiative being undertaken by the
AITC is to seek to increase and improve the information available
to investors. The objective being to ensure that investors gain
a clear understanding of the risk:reward trade offs involved with
any given share and are in a position to asses whether a share
matches their performance aspirations and risk tolerance. Effectively,
we wish to ensure that people are able to make intelligent decisions
with appropriate information thus reducing the risk that investors
could complain that they had been misled should catastrophic losses
be experienced in the future.
The basis of our initiative, which has been
devised after a process of consultation, is that we would publish
data on all splits on our website so that there would be a central
source for investors. The data would include:
1. A list of all holdings in other splits
and the value of those holdings.
2. An analysis of the split holdings, banding
them by the amount of bank debt and also by the level of their
own holdings in other splits.
3. Details of the company's borrowings and
4. A matrix showing the outcome for each
class of share at the wind up date given a range of positive and
negative returns form the underlying investment portfolio. Those
returns would be broken down by sub-portfolio where appropriate.
5. A statement of the "hurdle rates"
required to meet a range of outcomes depending on the class of
To return the initial subscription
To return the current share price.
To result in total loss.
To return any promised entitlement
We hope to start publishing this data in February
A copy of the letter that is being sent to Chairmen
of Split Boards next week is enclosed at Annex.
The AITC has conducted a research exercise to
establish attitudes to corporate governance. The results of this
research have been circulated to our Members and we have asked
them for their comments by the end of the year. We then intend
to produce a formal AITC guide or code regarding corporate governance.
A copy of the research paper is enclosed.
Letter to the Chairman of Split Boards
from the Association of Investment Trust Companies
Further to the FSA's response to the industry's
feedback regarding their discussion paper on splits, and the Treasury
Select Committee's hearing on splits, we have been asked to develop
ideas which could help to provide improved information to the
market. In this process, we need the support of the Boards.
One objective "illustrations of returns
and portfolio information" is designed to provide advisers
and prospective investors with better information to help them
assess whether the risks involved in investing in a particular
share are a good match for their objectives. We believe that this
will stimulate demand and improve liquidity.
To this end, we have proposals for illustrations
of returns that we are putting forward today.
Another objective (the "Data Project")
was to provide Boards whose companies had significant holdings
in other highly geared funds with information that would help
them better understand the look-through position of their portfolio,
the effective level of gearing and total expenses. This would
help them to assess the likely outcome for various capital return
and dividend flow scenarios.
Since this project was conceived in March, the
continuing fall in the values of holdings of splits by other splits
has made the potential future impact of cross holdings less important
as a further major collapse in split values has happened since
We are proposing an additional regular publication
for split capital and highly geared funds. One of the biggest
difficulties in assessing the risk: reward dynamics of various
share classes in companies with multiple sub-portfolios has been
to work out how likely it is that the returns required to meet
various hurdles are actually going to be delivered. This is probably
one of the major factors behind the purchase by so many investors
of shares whose risks they clearly did not understand.
The principle behind this proposal is that we
would collect from managers and publish on a regular basis:
A breakdown of the portfolio spread.
Also a detailed list of all holdings in other investment companies
by value, and top ten holdings for each sub-portfolio, updated
monthly. We will then publish that list together with a breakdown
of those holdings showing the extent to which they themselves
have bank debt shown in bands by ratio of debt to assets and/or
holdings in other investment companies. We would also show a breakdown
of any other sub-portfolios. This will enable investors to take
their own view on the potential returns of the investment company's
sub-portfolios. From these views, they would then be able to derive
their own assumptions for income and capital returns for the whole
portfolio. These could be applied to the matrix of final NAVs
and redemption yields (see below) thus enabling investors and
advisers to gain a proper understanding as to whether a particular
share offers risk:reward characteristics that meet their own objectives,
needs and appetite for risk.
Details of the overall portfolio
yield and the breakdown of the portfolio yield for each sub-portfolio,
Details of all borrowings, their
amounts, repayment dates and covenants applying.
With this data and using our existing data source,
Fundamental Data, we will also publish:
Hurdle rates, updated daily, for
each class of share to achieve a range of outcomes. This would
provide investors with a clear idea of how demanding the performance
requirements are upon the underlying portfolio, if the shares
are to achieve the investors' objectives. The hurdle rates would
be published to show the capital returns required from the portfolio
to result in (depending on the share class):
Initial subscription price.
Final NAVs and redemption yields,
updated daily, for each class of share based on a matrix of performance
scenarios (say from ¸10 per cent per annum to +10 per cent
per annum). This would enable investors to understand more easily
how sensitive their potential returns may be to relatively small
changes in the performance of the underlying portfolio. There
may be cases where the existence of sub-portfolios makes it desirable
to show each sub-portfolio's performance separately in a more
complex matrix. This would help investsor take an intelligent
view on the likely outcomes for themselves.
The sector clearly wants to avoid the danger
of investors buying shares without a proper appreciation of the
risks involved. If the data as suggested above were to be published
on the AITC's website, we believe that the opportunity would exist
for investors, analysts and their advisers to ensure that purchases
are made with eyes wide open. This would eliminate or at least
substantially reduce the risk of the sector being accused of misselling
or worse if substantial losses were subsequently sustained.
We will follow up this letter with your company
secretary to discuss the detail of the proposed intended data
collection. We hope that the information will first be published
in this format in February for end-January data.
Our data project collected the full portfolio
lists and gearing details as at the end of March of virtually
every split capital trust and certain other highly geared funds.
With this information, we have been building a complex model with
help from BFS who have sponsored a break-up valuation model for
cross holdings. We expect the model to be able to deliver a number
of conclusions at the macro level. However, the market has clearly
moved substantially since then and the value of holdings by splits
in other splits has, in most cases, been very seriously reduced.
If updated, the model will show:
The true level of assets (after
cancelling our cross holdings) underpinning the sectorthe
sector's break-up NAVwhich can then be compared to the
sector's market cap.
The sector's true level of gearing.
The sector's true level of expenses.
At the micro level, we expected to be able to
determine for each share class:
The NAV on a break up basis of
all the underlying holdings.
The effective gearing for each
The effective expenses for each
Scenario planning for various
Scenario planning for various
Further, we would expect to be
able to use the data to provide ratings for each share class,
customised for individual analsysts and managers. If this were
achieveable, we would want to gain agreement to a generally accepted
rating system for public dissemination.
We hope to complete the initial stages of this
project over the next 6 weeks and we will then revert to each
Board with a sample customised invididual analysis of each company
and share class based on data as at the end of March.
Of course, this exercise will show only the
type of data that will be available. The gap between March and
now means that the world has moved on considerably and we shall
have to decide at that point whether it is worthwhile collecting
the data on a regular basis in order to be able to re-run the
If, when Boards and market participants have
examined this data, it were deemed to be useful, we would then
make proposals on those parts of that data that we wanted to publish
publicly and for a continuation of the project by refreshing the
data on a monthly basis.
I hope that your Board will agree to the release
of the portfolio information as indicated. That is a list of all
investment company holdings, by absolute value and by value as
a percentage of your total assets, a breakdown of the portfolio
spreads, sub-portfolio yields and details of debt.
We expect the Treasury Select Committee to hold
a further hearing into the split capital sector before the end
of the year. In the meantime, we are doing everything we can to
explain the fact that split captial trusts have a valid role,
that they have enormous potential and that a majority of the sector
does not have the scale of difficulties being faced by a minority.
I would be delighted to meet with your Board,
if you would like to talk about these proposals or any other issue
you may wish to discuss.