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Select Committee on Treasury Minutes of Evidence

Memorandum submitted by the Association of Investment Trust Companies


  1.1  The AITC is the trade association representing investment trust companies. The Association's mission is: "To work with the Boards of Member investment trust companies to add value for shareholders over the longer term."

  Investment trusts have served investors well since the second half of the 19th century. They provide a professionally managed, diversified portfolio of equities at low cost.

  1.2  A large majority of investment trusts are not splits and many splits do not share the characteristics of those that have run into difficulties. All splits are intrinsically geared however and, as such, certain classes will fall more quickly in falling markets.

  There are 397 investment trusts in total of which 136 are splits or quasi-splits. 66 splits have announced changes of one type of another, indicating that they are suffering a degree of distress, since the recent difficulties emerged.

  The total assets of the investment trust industry as at the end of May 2002 were £64 billion. Of this, splits represented some £12.6 billion of which £4.4 billion was financed by debt. At the end of December 2000, split assets were £14.8 billion and prior charges amounted to £4.5 billion. An explanation of splits and common terms can be found in Annex C.[18]

  1.3  The AITC is deeply disturbed by the fact that a number of individual shareholders have suffered extreme losses on investments in splits. This distress is magnified because many buyers of Zero Dividend Preference shares were clearly looking for a low risk investment.

  1.4  The AITC has been working with Boards, managers, regulators, advisers and the media to identify ways of achieving the best possible outcome for shareholders, to explain what has happened and to ensure that lessons are learned for the future.

  1.5  The problems have been caused by the interaction of falling markets with developments in the structure of new splits launched in the last four years and by changes in the types of assets that were used to underpin those structures. Due to falls in markets that were unexpected in their severity and duration, their assets fell rapidly.

  Structurally, some funds increased their gearing by taking on bank debt (financial gearing) as well as or instead of issuing classes of share such as Zero Dividend Preference (ZDPs) (structural gearing).

  In terms of assets, they started to build portfolios comprised of a number of discrete sub-portfolios. For example a fund might have held a portfolio of income shares of other splits, a portfolio of high yielding bonds and a portfolio of technology shares. These splits with multiple portfolios became known as "barbells".

  These changes came about as a means of providing the highest possible levels of income to investors who were keen to invest in high-yield products at a time when interest rates (and therefore the levels of income available from traditional sources) were falling.

  Maintaining absolute yields at a time when interest rates were falling and so increasing the yield gap between these shares and yields available elsewhere inevitably led to an increase in risk and volatility and an increase in the underlying returns needed to make the products work.

  Most private investors and many independent advisers did not know that the risks attached to the various classes of share had increased.

  The structures were built on the premise that the bull market would continue. When a bear market arrived, the shares fell heavily causing a cycle of falls as a consequence of high gearing, the holdings by splits in other splits, the holdings in high yielding bonds and other growth stocks compounded by negative sentiment and publicity.

  1.6  The Association has noted the FSA investigations into allegations of collusion by managers, misleading advertising and misselling by advisers and awaits the outcome of those investigations.

  1.7  The Association has heard numerous rumours and anecdotes about collusion where managers and sponsoring brokers are alleged to have agreed to support each other's new issues.

  The allegations are that there was collusion between managers over the launch of new trusts. The charge is that they agreed to invest their client funds in each other's launches on a quid pro quo basis. In other words, the motivation behind certain investment decisions was not what was in the best interests of the investors who had entrusted their money to the fund manager, but was rather what was in the best commercial interests of the fund management house.

  The purpose would have been to guarantee new funds for each new issue, which would then borrow against those funds, growing the assets under management on which fees would be paid.

  The AITC has heard many of these rumours and awaits the conclusion of the FSAs investigation into the matter.

  1.8  The Association has examined the launch prospecti of many new issues and concludes that they did not, in general, make claims about the risk characteristics of the various share classes and that they did show what would happen under a range of different returns. The Association awaits the outcome of the FSA investigation into possible misleading marketing materials and misselling.

  1.9  The AITC has organised greater disclosure and transparency regarding the holdings by splits of shares in other splits.

  1.10  The AITC is also conducting a significant data project in which it is collecting and analysing details of the full portfolios of all trusts in the sector. This will allow the calculation of the true picture of the difficulties faced by a number of trusts.

  1.11  The AITC has made recommendations for better regular disclosure of holdings. It has also recommended that independent resources should be provided to Chairmen to help the Board assess at outset whether the fund they are proposing to govern is sufficiently robust.

  1.12  The Association is also arguing for the provision of detailed forecasts of the returns managers expect from the portfolio and to project how these would impact on returns to various classes of shareholder. The AITC is also calling for sensitivity analysis to be published showing how the shareholder returns are affected by marginal variations from the manager's prediction.

  1.13  The Association believes that improvement can be brought about by market pressure and that there is no need for changes to the regulatory regime.

  1.14  The amount by which total assets exceed debt is a good indicator of financial strength. As at 4 July 2002,[19] Cazenove found that.

  1.15  Source Cazenove 4 July 2002. First, looking at the entire Fundamental Data/Cazenove universe of 136 funds, the total assets are £11.4 billion. Taking off debt of £4.4 billion, leaves net assets of £7 billion, to which the market cap of the whole sector trades at a 2.8 per cent discount. Overall bank debt is well covered (2.21 times) by total assets net of other fund investments of £1.6 billion (the sector now owns 23 per cent of its own market cap).

  1.16  Source Cazenove 4 July 2002. The situation becomes more acute for those Splits with Total Asset/Debt ratios less then 1.5 times, which shows that for these 24 funds, the banks, in aggregate, are 85 per cent covered, if one assumes that the assets in other funds are not realisable (or are valueless). This clearly does not bode well for all classes of shareholder, yet despite this they trade at an aggregate 9.3 per cent premium to the published value of their net assets (again with the splits at mid price).

  1.17  Source Cazenove 4 July 2002. The good news is that there are 45 funds (33 per cent by number) with total assets of £3.8 billion (33 per cent of total sector assets), and a market cap of £3.3 billion (50 per cent of the sector) that have total assets to debt ratios over 4, or no debt at all. This group has only a tiny exposure to other funds and will clearly not be forced sellers (of anything) to repay the banks. Interestingly, this group offers the best value on a 3.3 per cent overall discount.


  2.1  The Association of Investment Trust Companies (AITC) was formed in 1932 to represent the interests of investment trust companies (ITCs). ITCs are quoted companies, which meet the conditions of S842 of the Taxes Act. This enables them to manage an investment portfolio without paying tax on the capital gains made on the disposal of assets provided they comply with requirements on distribution of income and other conditions of S842.

  The Association's mission statement is:

    "To work with the Boards of Member investment trust companies to add value for shareholders over the longer term."

  In the context of this mission, the Association is disturbed and distressed by the losses that have been suffered by some investors of all types but particularly the holders of Zero Dividend Preference shares (ZDPs), many of whom clearly believed that they had invested in a low risk product that would not suffer in the way that many split shares have done.

  2.2  We have been active in working with our members and their managers to develop ideas that limit losses in so far as is possible and in working with the media and regulators to ensure that the limited scope of the problem is clear in an effort to ensure that panic does not make a bad situation worse and cause investors to sell without consideration of all the facts.

  2.3  Investment trusts differ from unit trusts and OEICs primarily in that:

    —  They are closed-ended. They have a fixed number of shares in existence whereas unit trusts or OEICS are open-ended and expand and contract according to supply and demand.

    —  If a shareholder wants to dispose of a holding, they sell the shares on the stock market (either directly, or through a "plan" manager) at the market price. With a unit trust or OEIC, the shares or units are sold back to the manager at a price calculated by reference to the value of the underlying assets. This stockmarket selling process is why investment trusts can trade at discounts or premiums to their net asset value as they reflect supply and demand in the stockmarket. This can act in the buyer's or seller's favour. The pricing of shares is therefore different to open-ended vehicles, which fully reflect the asset values of their underlying holdings.

    —  The marketability of shares or units is significantly different in extreme market conditions. Investment trust market makers commit to make prices in shares at all times : unit trusts can suspend pricing or not deal in difficult market conditions.

    —  Investment trust companies have independent Boards of Directors responsible for the interests of shareholders.

    —  They can gear. A detailed explanation of gearing appears in Annex B.[20] This means that they can borrow money (in all the ways that any other company can borrow—from banks or by issuing bonds, debentures, use of different share classes and so on). Gearing is a tool that Boards (and the managers whom they contract to manage the company) can use to try to enhance returns and which magnifies returns (either way—up and down). If the investment portfolio rises by more than the cost of borrowing, then gearing has a positive effect on performance and so is positive for shareholders; if not then it will have had a negative effect on performance and thus for shareholder value. Generally, in a rising market gearing means that the net asset value will rise by more than the market, but it works both ways, in a falling market, the net asset value will fall by more than the market.

  2.4  Investment trusts are regulated by the UK Listing Authority (part of the FSA). The conduct of Directors is governed by Company Law. Investment trust status is only obtained from the Inland Revenue if a detailed set of conditions is met. The conduct of Fund Managers in managing the portfolio is regulated by FSA as are their marketing activities. The operation of savings schemes and ISAs are regulated by FSA as is financial advice provided by intermediaries.

  2.5  Today, the AITC represents 309 companies who manage between them £48.7 billion of gross assets. Of these 87 are splits managing assets of £7.8 billion. The total assets of the whole industry as at the end of May 2002 were £64 billion. Of this, splits represented some £12.6 billion of which £4.4 billion was financed by debt. At the end of December 2000, split assets were £14.8 billion and prior charges amounted to £3.8 billion.

  There are 136 splits or quasi splits with gross assets of £12.6 billion, about one-quarter of the total by value, one-third by number. Of these 136 splits, 66 have made announcements responding to market difficulties. Two have suspended trading. An explanation of splits and common terms can be found in Annex C.[21]


  3.1  The origins of split capital trusts go back over a hundred years. Investment trusts in the 1870s were split capital investment trusts, insofar as they offered different share classes to different investor types, although the name "split capital" was established later. Their founders, primarily in Scotland, developed a lifestyle concept based originally on Victorian financial engineers' understanding that different types of investor required different returns that could be delivered through different share structures from a single portfolio. Older investors, for example, typically seek high income and younger investors seek capital growth. Brokers to the late 19th century entrepreneurial companies, such as Foreign & Colonial and Scottish American Investment Trust, understood such needs, as well as offering access to new markets.

  3.2  Split capital investment trusts are trusts that typically have more than one class of share and a limited life at the end of which the assets of the company will be divided amongst the shareholders and the company's lenders according to predetermined rights and entitlements.

  3.3.  The shape of all new issues is dependent on the financial climate of the time. As in the 1870s when they were first formed, split capital trusts in the mid-1990s increased in popularity with investors when conventional investments offered low yields and low growth. Splits offered returns and characteristics that were not available either from lower yielding conventional equities or the low capital appreciation characteristics of bonds.

  3.4  The reason for issuing multiple classes of share is to separate different types of risks and returns from a single portfolio of assets. These are then channelled to different types of investors who have different needs, tax profiles and appetites for risk.

  The different classes of share in a split capital trust are ranked in order of priority for payment at a fixed wind-up date. So for every split capital trust there is a predetermined sequence in which the distributable income of the trust is paid and in which the final assets of the company are repaid to the various classes of share at the wind-up date. In the order of priority at wind-up it is very important to note that, if a split capital trust has any bank debt, this is usually ranked first for repayment before all classes of shares.

  3.5  An explanation of how splits work and of commonly used terms is included as Annex C.


  4.1  It should be noted that most investment trusts are not split capital trusts and that they have served investors well over many decades, providing diversified equity exposure with professional management at low cost.

  Furthermore, the majority of split capital trusts have not been exposed to the extreme problems of a minority and that a number have performed well despite difficult market conditions.

  4.2  The equity bubble of the late nineties led to complacency amongst the investing community about future market trends. It was fuelled by falling interest rates and equity yields and led to a chase for higher yields, which in turn fed the demand for the higher yielding securities, which splits offered. As long as equity values didn't fall, investors in most of the securities issued by splits could expect the returns that they were apparently being offered. But the bull market turned into a technology bubble, which has well and truly burst. The collateral damage has been devastating in some areas.

  In the investment trust sector, the pain has been most acutely felt by some split capital trusts and some other highly geared funds, particularly those exposed to the most volatile and illiquid sectors. An explanation of gearing is provided in Annex B.[22]

  4.3  High gearing will inevitably lead to pronounced losses if the underlying assets fall in value. So the holders of both highly geared ordinary income and capital shares have experienced the sort of falls in value that one might expect from highly geared investments given the extent and duration of the bear market.

  4.4  What was more unexpected was the way in which the Zero Dividend Preference shares (ZDPs) in some companies (those with high levels of gearing through bank debt, or holdings in other splits, some "high-growth" areas like technology or a combination of these factors) have fallen so severely in value.

  ZDPs were promoted as investments that exchanged risk for a limit on growth and did so in a tax efficient way. Of course the ZDPs were equity linked and it was conceivable that they might not pay their full final entitlement. However, many managers launching newer vehicles believed, by using cheap bank debt, high yielding bonds, portfolios of growth shares and investment in the income shares of other splits, they were diversifying away from the FTSE 350 shares that comprised the bulk of the portfolios of the majority of splits up to that point. These trusts with multiple portfolios, some delivering income and others designed to deliver capital growth, became known as "barbell" trusts.

  As we stand today, as a result of these factors, there will be some ZDPs that pay less than the initial amount invested and a few may well lose everything.

  4.5  The problems were caused by the sector's wish to meet the desire of investors for income in an era of falling interest rates. There was great demand for new issues that offered ever-increasing yield differentials above gilts and deposits. In many cases, these issues were riding up the risk curve to deliver the required level of income.

  4.6  Firstly, some new and restructured companies invested in ever-higher yielding stocks to generate the income to pay the dividends that they themselves promised to shareholders and secondly, bank debt was used to achieve a lower cost of gearing. This explains the trend towards new issues being committed to investing a proportion of their portfolio in riskier, higher yielding bonds and a proportion in other split capital trust income shares that might be investing in other split capital income shares themselves and so on. These income portfolios were combined with growth portfolios to form the aforementioned barbell trusts.

  4.7  The stream of new trusts that invested a proportion of their portfolios in other splits led to a situation where as much as 70 per cent of the income shares issued in 2001 were bought by split funds and other funds whose managers also managed splits.

  4.8  The increased use of investment in other splits led to a loss of clarity about the true financial position of those trusts.

  Firstly, if a geared fund invests in another geared fund that itself invests in geared funds and so on, it becomes impossible to quantify the effective gearing.

  Secondly, it becomes impossible to assess the true level of underlying expenses.

  Thirdly, the true value of the assets underpinning the share price can be impossible to calculate. If fund A buys shares in fund B that are at a premium, it is fund B's share price, not its net asset value that becomes a component of fund A's net asset value. As the group expands, one gets premiums on premiums on premiums and an increasing premium at the top level that may prove unsustainable. Total asset values of some funds therefore depend upon the market price of others.

  4.9  The existence of bank debt proved to be a destabilising factor. With falling interest rates, bank debt had provided an opportunity to gear ordinary income and capital shares at significantly lower costs than was achievable through the issues of ZDPs. However, as markets declined, banking covenants were breached and were required to take action to put themselves back above their covenant limits rather than just waiting for times to improve, as would have been the case where trusts were geared purely by ZDPs.

  4.10  Another factor was the unprecedented falls in share prices of many split trusts. The falls were driven in many cases by very low trading volumes and negative press and analyst comment, which created sellers. This selling drove down prices and so valuations of the other funds that held those shares.

  This also left some trusts close to breaching bank covenant conditions or critical assets vs. liabilities tests in the Companies Act 1985. This forced some trusts to cut or suspend dividends. This served to validate press and analyst comment and encouraged further selling and marking down of prices.

  4.11  Had markets continued to rise or had they experienced the short sharp shocks of 1998 or 1999 followed by rises to new peaks, there might have been no problem. But the reality of the bear market of the last two years has caused a number of splits to run into difficulties, some of them extreme.

  4.12  The actions taken by Boards in response to breaches of banking covenants tended to be:

  Firstly, having to sell the more liquid, higher quality stocks (rather than selling illiquid assets in a bear market) to repay debt and/or to increase the cash element of the portfolio (which was then offset against the quantity of the loan) and secondly, the issue of new shares to strengthen the balance sheet.

  4.13  A further factor has been the policies adopted by a number of funds in charging a high proportion of management expenses and finance costs on borrowings against capital returns as opposed to against income.

  For UK-based funds, the AITC's Statement of Recommended Practice (SORP) on accounting recommends that companies, if they choose to charge such expenses to capital, should charge them in proportion to their expected long-term total returns as between capital and income. Thus, if a company expects that 20 per cent of its total return will come from income and 80 per cent capital growth, it should charge 80 per cent of its management expenses and finance costs to capital.

  Offshore funds are not subject to the SORP and therefore can charge a higher proportion of expenses to capital.

  We have seen examples of funds with high portfolio yields charging as much as 80 per cent to capital. Under the SORP, if the portfolio yield were to be 6 per cent the implication would be that the manager expects that the 6 per cent yield will represent only 20 per cent of the total return. In other words that they expect 24 per cent capital return per annum and a 30 per cent total annual return.

  If the above assumption is wrong, and the capital returns are less than anticipated, the implication is that capital is effectively being paid out as income and that investors' capital is likely to be eroded.

  4.14  The undoing of some ZDPs has been that the bank debt has a prior ranking to their entitlements. Although ZDPs are de-geared investments at launch and remain de-geared whilst they stay covered—because a loss in the value of the assets will not initially affect their entitlement—as they become uncovered, they then become geared to the downside. Not what the typical risk averse buyer of a ZDP wanted or expected despite the fact that the negative hurdle rates (for an explanation see Annex C)[23] set out at launch showed what could happen. Indeed they now have.

  4.15  Promoters of the trusts that got into trouble hoped that the market would rise sufficiently for the investments to deliver on their buyers' expectations. In particular, they did not believe that assets would fall in value to the extent that the fund would fail to meet zero holders' expectations. In the event, the market has fallen more severely and for longer than had been imagined.

  4.16  There are now a number of FSA investigations into the allegations of collusion around the new issue market and whether there has been mis-selling by fund managers and IFAs. It is not known at this stage whether any rules have been broken.

  4.17  Earlier splits, before the common adoption of bank debt and of investment in other splits, generally had portfolios based around shares in the FTSE 350 index rather than the newer "barbell" models that used technology or healthcare or US, European or Far Eastern shares combined with high yielding bonds and/or holdings in other splits to provide exposure to growth areas combined with high yield.

  The splits that were most common pre-1998 were those with ordinary income shares and ZDPs. The structure was typically supported by a portfolio of FTSE 350 stocks and had little or no bank borrowings.

  A fair way to describe the shares would be to say that the ordinary income shares provided investors with a well-above market income from a portfolio typically yielding a 30 to 50 per cent premium to the UK equity market and a return of the initial investment at wind-up provided reasonable capital growth requirements for the portfolio were met. If things went well there could even be geared capital growth on the upside. The typical portfolio capital return required to achieve this was in the order of 3-4 per cent per annum. This did not seem unreasonable for this type of portfolio.

  The ZDPs usually had their final entitlement more than covered on day one and again, from this type of portfolio, there seemed only a remote chance of there being an actual fall over a seven year plus period. This still may be the case for the vast majority of non-fund-of-fund ZDPs (those that do not invest to any material extent in other split shares).

  4.18  But, as market conditions changed, as portfolios became more exotic, as companies started to invest greater proportions in other splits, as more bank debt was taken on, as a greater proportion of expenses were charged to capital, the risks of loss in a severe bear market increased. It is not clear that investors and their advisers properly understood the fact that the risks of loss were increasing or that this fact was communicated.

  4.19  As we write the FTSE 100 Index has declined by over 35 per cent from its peak and we are in the grip of just such a severe bear market.

  4.20  The fact is that these different types of share did not share the same risk profile as the "earlier", more traditional splits.

  The ordinary income shares were perhaps quite likely to depreciate, given that their high yielding portfolio was unlikely to show much capital appreciation, so the "growth" part of the portfolio needed to increase significantly for the shares to just stand still. Of course, in the event, many of the "growth" portfolios turned out to be anything but. The reasonable possibility of a full return of capital perhaps had become an outside chance.

  4.21  The ZDP shares which, in the past, had been well below average risk had become more volatile, particularly as, with the introduction of bank debt, there was now a banker with a prior call on the assets and with the power to force a premature wind-up or debt repayment (at the worst possible time for the ZDP and other shareholders) if things went wrong and covenants were breached.

  4.22  Investors and advisers did not know and had not been explicitly told that many new issues were more vulnerable to declining markets than the "traditional" split structures had been.

  4.23  The Association has heard numerous rumours and anecdotes about collusion where managers and sponsoring brokers are alleged to have agreed to support each other's new issues.

  The allegations are that there was collusion between managers over the launch of new trusts. The charge is that they agreed to invest their client funds in each others' launches on a quid pro quo basis. In other words, the motivation behind certain investment decisions was not what was in the best interests of the investors who had entrusted their money to the fund manager, but was rather what was in the best commercial interests of the fund management house.

  The purpose would have been to guarantee new funds for each new issue, which would then borrow against those funds, growing the assets under management on which fees would be paid.

  The AITC has heard many of these rumours and awaits the conclusion of the FSAs investigation into the matter.


  5.1  Boards and managers have been highly active in their efforts to stabilise the situation. Unfortunately, in a number of cases the resulting action has been to no avail although in many cases they have succeeded in stabilising the situation, albeit at a significantly lower level of assets and share prices than at outset.

  5.2  There have been a number of preference share issues in an attempt to strengthen balance sheets. As the situation deteriorated, however, it became impossible to issue these shares for cash and they started to be issued by way of stock swaps of other split shares from the portfolios of other fund-of-fund splits. This attempted remedy has now all but ceased.

  5.3  Boards are now suspended of dividends, reducing expenses, repaying debt and changing expense allocation policies. These actions are stabilising the position albeit that the companies concerned will continue with both their assets and their share prices at a far lower level than when they started.

  5.4  Effectively, there are now a number of different positions in which splits find themselves:

    1.  There are many trusts that have been unaffected which continue to fulfil their original investment objectives.

2.  There are those whose liquid assets are higher than their bank debts, who have taken measures to minimise the risk of further capital erosion, perhaps by suspending dividends or by cutting expenses. They have lost a great deal of shareholder value, but may recover some of that if markets recover over the next few years.

3.  There is a group whose shares are widely owned by those splits in the greatest dificulties but who themselves do not suffer from bank debt or investment in other splits. Their own share prices may have fallen heavily because of the possibility that there will be distressed owners of the shares forced to conduct a fire sale. Given reasonably benign markets up to the wind-up dates of these companies, they should recover and indeed some could do well.

4.  Finally there is a small minority who stand next to no chance of repaying anything to any shareholders, even ZDP holders. They are only solvent because the bank has not yet recalled their loan. The banks have not yet done so because they have already taken the cash from the sale of all the liquid holdings so they may as well wait for the manager to conduct an orderly liquidation in the hope that there may be some recovery in values of the illiquid splits holdings over time.

  5.5  The AITC is not a regulator, but it is a guardian of the good name of the investment trust industry. The Association has not ducked this very important issue. Instead, we have engaged with the regulator and the media to explain, openly and honestly, what we see to have been the problems and to encourage Boards to consider ideas, which may help them put their companies on a more stable footing.

  5.6  Examples of letters written to the Chairmen of split trusts and extracts from a speech made by the Director General to the AITC's 2002 Conference for Directors are included in Annexes D and E.[24]

  5.7  The AITC has successfully encouraged greater disclosure of the details of splits holdings in other splits and we are currently engaged in a data project that will put complete portfolio holdings for the whole universe of splits together thus enabling the full picture to be viewed for the first time.

  This data work will enable the calculation of the value of the non-split assets underpinning each company's structure. It will also enable us to provide Boards with the true hurdle rates required from these assets to deliver returns to shareholders.

  The intention is that it will enable the analyst community to develop an improved methodology for understanding and rating the quality of different companies and their various classes of share.

  5.8  We are arguing for split managers to state clearly their central case assumptions for the revenue and capital growth returns on each segment of their portfolio. We want them to explain what their expectation would mean for the returns of each class of share up to the wind-up date. Further we would like them to project "what ifs?" that show how sensitive each share is to variations in their central assumption.

  Taking example 2 (from Annex C):

Statement of portfolio expected returns:
Bond portfolio (25%) expected return:
6% income: 3% capital growth
Splits (income shares) porfolio (25%):
8% income: 1% capital growth
Growth shares Portfolio (50%):
1% income: 9% capital growth
Total expected return:
4% income: 5.5% capital growth
Total expenses 1% pa all charged to income
Total returns after expenses:
3% income: 5.5% capital growth
Income after expenses available for ordinary income shares:
£3 million
Income payable to ordinary income shares:
5% pa
Final assets at 5.5% pa growth:
£171 million

  Based on expectations returns would be:

Final ZDP value: £80 million (full entitlement) a 100 per cent gain.

Final ordinary income shares value: £91 million a 52 per cent gain.

  Hurdle rate to produce full entitlement for ZDPs: -2.2 per cent per annum capital growth 7.7 per cent below expected return.

  Hurdle rate to return initial investment for ZDPs: -8.8 per cent per annum 14.3 per cent lower than the expected return.

  Hurdle rate to return investment to ordinary income shareholders: 3.4 per cent per annum 2.1 per cent lower than the expected return.

  Hurdle rate to wipe out ordinary income shares: -2.2 per cent per annum 7.7 per cent lower than the expected return.

  Even better, is to quote "equity hurdle rates" ie where parts of the portfolio are assumed not to grow or only grow at a fixed (positive or negative) rate per annum and assume that the equity part of the portfolio only grow at a variable rate (this variable rate is the equity hurdle rate). In the example given above with Bonds at a fixed growth rate of 3 per cent per annum, and splits at 1 per cent per annum, then the equity part of the portfolio has to grow at 4.65 per cent to give the ordinary shares back their original investment (cf 3.4 per cent above the level if one were to assume that the whole portfolio grows at the same rate).

  As above, we would like to see split capital trusts and their managers quoting hurdle rates to illustrate what capital returns are required from the underlying portfolio up to the wind-up date to return the predetermined redemption price (if any); to return the initial investment and to return current share price; to result in wipe out.

  5.9  The Association has also argued, that on the launch of a new company, Directors should be brought in earlier in the process and have access to independent advice on the robustness of the proposed structure.

  5.10  The Association has been successful in ensuring that the media understand that the problems are confined to a minority of split capital trusts and that conventional trusts are almost entirely unaffected.

  5.11  Despite this, there is no doubt that the industry as a whole has been affected, but we believe that there will be a rapid recovery in sentiment as the process of stabilisation of the trusts in difficulties draws to a close.

  This will, in time, provide some clear water, and it is important for investors that not only splits, but conventional investment trusts as well, regain their position.

  5.12  Splits can do things that no other collective investment can. Property structured and with clear explanations of the risks being taken, of the assumptions being made and of the nature of the portfolio that underpins those assumptions, they can help to solve financial planning problems in a unique way.

  5.13  Investment trusts have a valuable role to play in the future savings and investment market. The AITC would welcome any comment or feedback from the Committee that would help us to ensure that the lessons from these problems are learned.

18   Ev 38. Back

19   Ev 35. Back

20   Ev 38. Back

21   Ev 38. Back

22   Ibid. Back

23   Ev 38. Back

24   Ev 42, Ev 43. Back

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