Split Capital Investment Trusts

Understanding Split Capital Investment Trusts

Split capital investment trusts (often called ‘splits’) are a unique form of investment fund that segments its assets into different share classes. Each class has distinct rights regarding the income generated by the trust and the ultimate capital repayment. This structure caters to investors with varying risk and return expectations.

Key Concepts

The core idea behind split caps is to segment the trust’s assets and future returns into different types of shares:

• Income Shares: These shareholders receive the trust’s income, often paid out regularly. They typically have limited capital growth potential.
• Capital Shares: These shareholders are entitled to the trust’s capital growth. They receive little to no income, with their return primarily coming from the appreciation of the underlying assets.
• Zero Dividend Preference Shares: These shares are designed to provide a fixed capital sum to the holders at the trust’s winding-up date. They are effectively a loan to the trust, paying no income but receiving a predetermined amount of capital.

Deep Dive: How They Work

A split cap trust invests in a portfolio of assets, such as equities or bonds. The income generated from these assets is distributed to the income shareholders. Any capital appreciation is reserved for the capital shareholders. The zero dividend preference shareholders are repaid their principal (and sometimes a small fixed return) at the trust’s termination date, after which any remaining capital goes to the capital shareholders.

Investment Strategies and Applications

Split caps can employ various strategies:

• Income Generation: For investors seeking regular income with less emphasis on capital growth.
• Capital Growth: For those willing to take on more risk for potentially higher returns from asset appreciation.
• Leverage: The structure inherently creates a form of gearing, amplifying both gains and losses for capital shareholders.

Challenges and Misconceptions

Split caps can be complex and carry significant risks:

• Gearing Risk: The leverage inherent in the structure means that a small fall in asset values can disproportionately affect capital share values.
• Interest Rate Sensitivity: Zero dividend preference shares are particularly sensitive to changes in interest rates.
• Liquidity: Some older or smaller split caps may have limited liquidity, making them difficult to buy or sell quickly.

FAQs

What is the primary risk for income shareholders? The main risk is that the trust’s income may not be sufficient to cover the dividends, or that the trust may be wound up prematurely with insufficient assets to repay zero dividend preference shares.

How do capital shareholders benefit? Capital shareholders benefit from the growth of the underlying assets, especially if the income and zero dividend preference shares are fully satisfied and there is surplus capital remaining.