Harsh Lessons for Long-Term Savers ; `Zeros' Were Said to Be Risk Free. but on Top of Bad News, Paula Hawkins Finds More Fears Emerging
Hawkins, Paula, The Independent (London, England)
Zero dividend preference shares have long been sold to cautious investors as the perfect way to save for specific objectives, particularly school fees. But since the stock market collapse after 11 September, holders of zeros have been shocked to find that the risk profile of these instruments is much more complicated than they thought. The sector has been spooked by bad news, the latest being the failed reorganisation of the Geared Income Investment Trust.
Zeros are issued by so-called split capital investment trusts (see the article below). The dramatic fall in the markets in the third quarter of last year hit all investors hard, but many splits were particularly badly affected. Some of these trusts had made significant investments in the securities of other split capital trusts, in an attempt to maximise returns for income investors. In a rising market, this can be a lucrative strategy. But once the markets begin to fall, the decline in net asset values of one trust affects the portfolio of any other trusts that hold its securities. The "magic circle" thus established between fund managers can become a vicious circle.
The Financial Services Authority (FSA) has launched an investigation into the sector to establish whether there is any evidence of market collusion between fund managers who invested heavily in each other's split capital trusts. It expects to report its findings within the next couple of months. However, the FSA's examination will focus on whether fund managers have been working together in an attempt to raise prices artificially. It will not be looking at whether the ways in which zeros are priced, and their potential risks assessed, are flawed.
Yet experts point out that so many split capital funds have cross holdings that valuing the assets of the investment trusts can be a Herculean task. Tim Lewis, of independent financial adviser (IFA) Lewis & Co, says: "No one really knows what the net asset value [of a split capital investment trust] is, and it is almost impossible to work it out. For example, Britannic Income might own pounds 2m of Murray Emerging, which might own pounds 1m of Britannic Income, which might own pounds 1m of Aberdeen High Income, and so on. You would have to devise a huge flow chart to find out where the assets are."
The fact that, as with all investment trusts, asset values are quoted before management charges are taken into account means values appear higher than they are in reality. In order to get a real picture of the asset value, one needs to subtract the management charge. But in the case of those zeros heavily invested in other splits, there might be more than one set of charges to take into account. "Inevitably, management fees are part of the equation," says Roddy Kohn of IFA Kohn Cougar. "There will be some double charging in some cases, but in others fund managers might come to an agreement so that this does not happen."
Mr Lewis argues management charges should not concern holders of zeros too much: "They are usually paid out from the dividend stream, so it is income investors [not zero investors, due to receive a lump sum] who will suffer the costs."
Anyone considering investing in zeros should start by examining how much debt the trust holds. Many split capital trusts borrow from banks in order to finance investments, a process known as gearing. Highly geared funds are problematic because, although zero investors are ahead of capital and income shareholders in the queue for a payout when the fund is wound up, it is the banks that are first in line. In a falling …
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Publication information: Article title: Harsh Lessons for Long-Term Savers ; `Zeros' Were Said to Be Risk Free. but on Top of Bad News, Paula Hawkins Finds More Fears Emerging. Contributors: Hawkins, Paula - Author. Newspaper title: The Independent (London, England). Publication date: March 1, 2002. Page number: 16. © 2009 The Independent - London. Provided by ProQuest LLC. All Rights Reserved.
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