Toxic legacy and bad climate thwart split cap launch
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It is eight years since the split capital crisis, but investors have long memories. Invesco Perpetual shelved its split cap launch, saying that the level of support did not match its minimum requirement.
It is tempting to say that if a group with the investment credentials of Invesco Perpetual cannot generate support for a new fund, the structure is defunct. What does this move say about the health of the split cap sector?
Nick Greenwood, the chief investment officer of iimia, says the investment premise of the Dual Return split capital investment trust was sound: “It should have been successful. For this type of structure, you need a solid income portfolio and the type of income funds run by Invesco fit this perfectly- full of high quality, high yielding defensives. It would have been ideal for splitting into capital and income.”
The original fund was marketing itself as a back-to-basics split capital fund. There would be no swapping zeros for bank debt or investing in other split cap funds. It would simply have been a high quality equity income portfolio, with capital and income shares.
Also, for the time being at least, the tax advantages remain in place. Any income received from the income shares of split capital trusts is taxed as a capital gain rather than income. For most investors this is a rate of 18% rather than 40% or 50%. (article continues below)
In spite of this, the launch was indefinitely postponed. Is the split cap structure still too tarnished to support a launch? Greenwood says that splits still carry a legacy: “If you call it a split, people often think you’ve got a fund full of toxic assets, even though the problems of the split capital crisis had nothing to do with the actual structure of splits.”
With limited demand, any launch would have to be doing something different. Nick Sketch, a senior investment director at Rensburg Sheppards, says that the fund may have looked too similar to Invesco Perpetual’s trusts.
”If you call it a split, people often think you’ve got a fund full of toxic assets”
Also, although Invesco Perptual’s clout in the unit trust arena is undeniable, it is not a familiar name in split caps. Sketch says that the withdrawal of the trust does not kill the idea of split cap launches altogether, but launching zero dividend preference shares, for example, from trust vehicles rather than launching new trusts is likely to be more common.
Stephen Peters, an investment trust analyst at Charles Stanley, says that market conditions will also have played a role in Invesco Perpetual’s decision. He adds that when the original fund was first mooted, it was supported by a combination of rising equity markets and the group’s natural income bias. However, as equity markets rose, the attraction of the capital shares diminished. He adds that if equity markets were to suffer a setback, a trust may garner more support.
Although the crisis led to a lengthy hiatus in split cap launches, the last two years have seen successful capital raising exercises from several trusts. This was seen particularly in the private equity arena from trusts such as Electra and Ecofin, as banks tightened their lending criteria.
It could also be argued that the trust’s failure exposes problems with the way investment trusts are launched. Greenwood says: “The trouble with launching new investment trusts is that all the money has to be raised up front. This is difficult to do, unless the sector happens to be particularly ’hot’. That means that trusts are not necessarily being launched at the right time.”
Here the contrast with Anthony Bolton’s China Special Situations trust is informative. The Bolton fund has had no trouble raising assets, but China is “hot”.
Peters says: “There have been Brazil funds launched after the Brazil market is up 100%. The same was true of property funds in 2005-06 or private equity funds in the early 1990s. Unfortunately it is simply the way money has to be raised. There were some great ideas last year, particularly in the distressed debt arena, but with people worried about paying their mortgage, few clients were interested.”
The split cap structure is alive, but the name may still be too tarnished to support an entirely new launch. Better markets may have generated more interest, but there is an argument that the fund simply looked too similar to Invesco’s existing trusts. Fund groups may have more success converting existing trusts than launching new ones in the short term.
