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Concept

Every Split Capital Trust has at least two classes of share. Those that are available are Zero Dividend Preference shares, Income shares, Annuity Income shares, Ordinary Income shares (also known as Income and Residual Capital shares) and Capital shares. The type of share you invest in is ranked in a predetermined order of priority, which becomes important when the trust reaches its wind-up date.

Wind-Up Date
Zeros
Income
Capital
Gearing

Wind-Up Date
Nearer to the winding-up date, investors who own shares in the trust are presented with a number of options. To continue the life of the trust, to wind-up the trust and roll investments over into another trust or to wind-up and take the cash.

When a trust is wound up, the different classes of share are repaid in a particular order of priority. If the Split has acquired any debt, debentures or loan stock, then this is paid out first, before any shareholders. Next in line to be repaid are Zero Dividend Preference shares, followed by any Income shares and then Capital. Although this order of priority is the most common way shares are paid out at the wind-up date, it may alter slightly from trust to trust.

Zeros
The principal characteristics of a Zero Dividend Preference share, ZDP or "Zero", are:

- No dividend is payable at any stage to the Zeroholder. In effect, therefore, the interests of the Zeroholder are principally in capital return rather than income from the trust.

- At the redemption date (the date specified on the establishment of the split for its winding-up), the Zeroholder is entitled to receive a pre-established redemption price provided that there are sufficient assets in the trust.

- In determining whether there are sufficient assets to meet the payments due to Zeroholders, the only prior call on the assets of the trust is in favour of any bank which has lent money to the trust.

Income
Investing in a traditional Income share will usually entitle you to most or all of the income generated from the assets of a trust until the wind-up date. This share type also offers a degree of capital protection, as you will typically get most of what you originally invested back at the end of the Split's life. This predetermined value is usually expressed as a redemption price per share.

Other types of Income include Annuity Income, which concentrates on producing a very high and rising yield, but has virtually nothing in the way of capital protection. In other words, all of the capital is converted into income for this share class. You are entitled to a nominal value at the wind-up date, usually 1p, but you will lose your initial investment if you hold the shares until this time.

Ordinary Income shares (also known as Income and Residual Capital, Geared Ordinary or Highly Geared Ordinary), offer high income and the right to a share of all the remaining assets of a Split after prior ranking shares, including Zeros, and other charges have been repaid at wind-up. Income shares are generally viewed as medium risk, but Ordinary Income shares have an extra element of risk due to the unstable nature of the final capital return. Investors have more of a chance of losing their initial investment.

Capital
Capital shares have the highest risk of all the share classes. At wind-up shareholders are entitled to most or all of the remaining assets after prior ranking share classes have been paid. Unlike other share classes, Capital shares have no predetermined growth rate and their success ultimately depends upon the success of the trust's underlying portfolio. If a trust has performed badly there may not be enough left to pay back Capital shareholders after preceding classes have been paid. Despite their high volatility, this share type is seen by many as an attractive investment because the higher the risk the higher the potential gain.

Split Capital Trusts also issue Packaged Units. Packaged Units combine certain classes of share, usually reflecting the same number of share classes in the trust, and usually in the same ratio. This makes them essentially the same investment as an ordinary share in a conventional Investment Trust.

Gearing
In conventional Investment Trusts gearing refers to how much a fund borrows. The process is designed to increase shareholders returns by achieving growth at a faster rate than the cost of borrowing. This can be beneficial when markets are rising as gearing can be used to enhance gains. However, gearing can enhance losses when a sector is falling. Gearing is usually expressed as a percentage of the total assets of the trust, where a figure of 100 indicates no gearing. A gearing factor of 120 means that on a trust with equity of £100 million, it has £20 million of debt (bank borrowings).

Splits use gearing in the conventional way but it is also present in their structure. Gearing is most commonly created by Zero Dividend Preference shares as they are used to provide better returns for the share classes that rank behind them. Each class of share is geared by the presence of those ahead of it in the order of priority. For example, Capital shares are usually the most highly geared share class and are therefore the most risky as they are the last in line to be repaid at wind-up.

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