This new dual return fund could be attractive for higher rate taxpayers.
After a few years of negligible activity on the split capital front, investment trusts are once again issuing different classes of share to meet the needs of different investors. As long as the lessons of the early part of this decade have been learned, that's good news for investors. One in particular has attracted my attention.
New classes of share
Zero dividend preference shares are issued by an investment trust as an alternative to debt. The holder receives no income but instead is entitled to a predetermined capital gain at a particular date in the future, as long as the assets are sufficient to cover the obligation. The riskiness of a particular offer can be gauged by its so called 'hurdle rate', the annual amount by which the assets can decline before the commitment will not be honoured.
For example F&C Private Equity Trust (LSE: FPEO) announced a month or so ago a zero issue with a gross redemption yield of 8% pa, with a hurdle rate of around 20% pa. In other words, gross assets of the trust could fall 20% each year and the zeros would still provide that 8% pa.
The increased appetite for zeros among the investing public means demand for these issues has been strong and most prices have risen. As a result of this strong demand, investment trusts are embarking on other capital structures. The one I want to highlight here is the Invesco Perpetual Dual Return Fund, announced a couple of weeks ago.
A return to investment trust roots
The Invesco Perpetual Dual Return Fund is noteworthy because, as far as I can recall, there has not been a similar structure launched for decades.
Basically the new trust will return to a traditional, simple structure of two classes of shareholder, represented by two types of share. First, there are the income shares, which will be entitled to all the dividends generated and a capital return of 100p at wind up (the trust has a seven year life). Secondly there are the capital shares which enjoy any and all capital growth above 100p per share, but receive no income.
What makes this structure attractive is the recent changes in UK taxation and the tax shelters available to UK investors. We are now in a fiscal environment where income will be taxed at higher band rates of 40% and 50%, but capital gains are taxed, regardless of income, at 18%.
Under these rules it makes sense for anyone who is a higher-rate taxpayer to hold the income shares in an ISA and hold the capital shares outside the tax shelter. (It's worth noting though that there could well be further changes to the tax rules when the Pre Budget Report is announced on 9 December.)
The overall dividend yield is anticipated to be 3.5%. For the income shareholder this would mean a starting income on their investment of 7% pa (which may of course increase if dividend growth is achieved.) The capital shareholders receive a similarly geared play on capital growth. If the assets of the fund increased by 10% pa (for example) their return would be 20% pa.
Alternatively, an investor can simple hold both classes of share (a 'unit') which would give the shareholder plain vanilla exposure to a portfolio of UK equities, managed by a respectable investment group, for a period of seven years. Oh, I almost forgot to mention, the manager will be Martin Walker who cut his teeth with investment legend, Neil Woodford and has outperformed the average fund manager over a cumulative five-year period. His most recent investment 'blip' was this year when he probably, like Woodford, favoured defensives over the 'dash to trash'.
The trust will not take on any borrowings, and although the manager can invest in bonds it is anticipated the fund will be 100% invested in equities. Annual management fees will be a reasonable, but not outstandingly cheap, 0.75% pa. In addition, launch costs are to be capped at 2% and will be recouped at a rate of 0.4% pa for the first five years.
This is a relatively simple way to gain geared exposure to either income or growth in a tax-efficient manner. We could do with more innovation like this.
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