Split capital trusts have a very poor reputation, but they may have a role for some investors.
I'm pretty sure that most Fools wouldn't even consider investing in split cap investment trusts. And that's understandable. Many investors -- including a member of my family -- were persuaded to buy shares in the trusts on the basis that they were lucrative but low risk vehicles. Sadly, many such investments proved to be disastrous.
Many split cap trusts had taken on too much debt and had invested too much money in other split cap funds which were themselves indebted. As a result, some investors lost all their money.
So I can understand why many people steer clear of splits. However, the fund management industry has launched a new PR campaign to try and persuade private investors to return to the funds, and I wondered if the message behind the campaign stacked up.
But what exactly are split caps?
The idea behind split caps is that one investment trust should offer different investment opportunities for investors with different needs.
In simple terms, shares in a split cap are divided into two classes. (The structures of funds vary. Many of them have three classes.) The funds normally have a pre-determined lifespan too. Owners of income shares normally receive all the dividends paid to the fund plus they hope to receive the value of their original investment when the fund is wound up.
Owners of capital shares should receive all of the capital gains from the shares in the fund's portfolio.
Take an imaginary father and son. The father is retired and wants a nice income stream to supplement his pension. The son, by contrast, is looking for capital growth to build up an investment pot for his twilight years.
The father could, of course, invest in an equity income unit trust, or create his own portfolio of high-yield shares. The son could build his own portfolio of growth shares, or buy units in a tracker fund.
So why bother with split caps?
Split cap fans argue that their favoured funds can be lower risk than conventional income funds. That's because equity income funds tend to buy shares paying a high dividend. But a split cap fund can buy shares with lower yields and still pay a high income to owners of the income shares. Hence, you're getting a high yield from a more diversified portfolio.
I don't really buy this argument as I'm not convinced that high yield shares are riskier than the market as a whole.
Another argument is tax.
This is especially relevant to a third type of split cap share -- zero dividend preference shares. These pay no dividends during the life of the fund, but the accumulated income is paid out to holders when the fund is wound up. The tax authorities consider the accumulated income to be a capital gain, so you might be able to shelter your profits within your annual exemption for capital gains tax (CGT).
Of course, if you're a top notch investor, you may be using up your CGT allowance already. And even if you're not, it's often a mistake to let tax considerations make too big an impact on your investment decisions.
The final argument for buying a split is that sometimes the share prices just get too cheap. There were plenty of bargains two or three years ago, but looking through the splitsonline website this week, I reckon those days are pretty much over -- for now at least.
Still, I'll keep an eye on the sector. A bit of bad news for one fund could drive prices down across the board and then we might see some bargains return.
