Select Committee on Treasury Minutes of Evidence

Annex D


  As the Chairman commented in his opening address, it is occasionally suggested that the AITC is in some way hostile to splits or run in the interests of conventional trusts. The truth of the matter is that we are very much in favour of all uses of the investment trust structure that serve to benefit their shareholders.

  Indeed, the AITC has worked hard on behalf of splits. As well as the work we've done with the media over the past nine months, explaining splits and encouraging a more balanced view, we have produced a guide to splits in Investment Week and we are producing a consumer orientated splits guide in Bloomberg Money in April, we are also producing a new factsheet, a new section on the website and we are undertaking considerable IFA training.

  We operate a splits marketing working group and we have carried out a project to refine, define and simplify the terms and jargon employed in the sector. The splits managers analysts and professional advisers have been entirely supportive of this process. So we are anything but hostile to splits.

  However, with the benefit of hindsight, there is no doubt that mistakes have been made over the past five years and that this has led to some dramatic losses for investors and a tarnishing of the name of the whole split capital sector. And we have to hold our hands up and admit that the problems are not just the result of unforeseeable behaviour by the markets or of the reporting by the media. It has clearly been unrealistic for new issues to seek to maintain real yields even as interest rates were plummeting and equity yields falling. The inevitable reduction of portfolio quality has played its part.

  The practice of splits investing in splits has led to gearing being piled onto gearing until it has become impossible to get a handle on how geared some funds really are. The Association has led an initiative to increase disclosure and transparency for all affected funds not only those who are Members. This initiative, supported by the FSA, is probably not the final destination but, working with Boards and managers I am confident that we will work our way to a better long-term disclosure structure.

  There is a place for ungeared funds of funds to provide diversification and professional management of a complex product, but I am very unsure of the rationale for the geared fund of funds. There is enough gearing and risk in the underlying portfolio to make additional gearing unnecessary and if the large majority of equity subscribers to these funds are other funds, the impact is largely to costs on costs. The real external demand has in fact been remarkably low when one considers the fact that of nearly £2 billion of equity raised last year in split issues, over two thirds of the money subscribed came from other splits, and much of that as stock swaps rather than cash.

  As for the other shareholders, there are a lot of very worried zero holders out there, many of whom believed, and were told, that were buying a low risk product. When they see the risk ratings as assessed by professionals then re-classified from lowest risk to highest risk, their complaints can hardly be described as sour grapes resulting from financial loss.

  To compound their problems, the introduction of bank debt in front of zeros has pushed them over the cliff much more rapidly when they become uncovered than used to be the case in simpler structures and this additional risk was neither understood nor explained until it went wrong.

  Much money has been made out of splits over the last few years; by brokers, fund managers, lawyers and accountants. But the effect of unexpectedly poor markets and self-inflicted mistakes has been disastrous for many priviate investors who stand at the bottom supporting an inverted pyramid and has set back the development of the split sector by a decade.

  Furthermore, the AITC has constantly been told that we're party poopers because we won't roll over and allow all costs to be allocated to capital. We've seen trusts with portfolio yields of 6 per cent allocating 80 per cent to capital—this means they are assuming a total return of 30 per cent from a portfolio of bonds, high yielding shares and other splits! Ironically, some of the more stretched trusts are now making their accounting policies more conservative again so that they can bring down their payable dividends to strengthen the balance sheet.

  Remember, it is the Board not the manager or still less the auditors, who are responsible for the preparation of the accounts and the selection of accounting policies. I sometimes wonder if the Board of a new trust is appointed when it is too late to change the structure of the fund.

  The AITC, the Managers, professional advisers, bankers and regulators are all working co-operatively to ensure the least painful outcome for shareholders of the various companies that are experiencing difficulties. We are all absolutely committed to restoring confidence and protecting shareholders' interests.

  Splits should be a fantastic way of providing solutions to a diverse range of financial planning problems, but some of the practices of the recent past may have gone too far. I like splits. I like what they can do and the way in which they can be constructed to provide solutions to people's financing planning needs. But the AITC will not act as an apologist for bad practice.

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Prepared 17 October 2002