From its peak on 1 September 2000 to the low point reached in the days following the terrorist attac...
From its peak on 1 September 2000 to the low point reached in the days following the terrorist attacks on 11 September, the FTSE All-Share fell by over 35%, constituting the worst bear market experienced since the early 1970s.
Against this background, the split-capital sector, where structures embody high levels of gearing, has been particularly hard hit. In particular, the sharp declines in splits' portfolios have caused some trusts to breach or risk breaching covenants relating to bank borrowings.
Other trusts have run into problems in connection with Section 265 of the Companies Act, which prevents the payment of dividends if gross assets fall below 150% of total liabilities.
In addition to these technical difficulties, the split sector has had to contend with a barrage of negative press comment that seems to have gone way beyond a balanced discussion of the risks.
Contrary to what has been suggested by some of the journalists, banking and systemic risk issues are not present in every split trust, nor is it rational to suggest that every class of share issued by every split trust is a high-risk instrument.
There are many trusts with ample asset backing, which offer well-covered zeros and ordinary income shares with both a reliable income stream and prospects for capital growth. Furthermore, investors in zeros should remember that even if their final repayment entitlements are not met in full, they are likely to get most of it and they will therefore get a very attractive annualised return from current levels.
Within the split sector, funds of funds, tech specialists and trusts with significant exposure to high yield bonds have been worst hit. In these sub-sectors, some formerly well-covered zeros have seen their asset backing eroded substantially, and the residual equities in some of these structures (ordinary and capital shares) have seen their net asset values fall to nil.
Managers in these sectors have nevertheless had some success in seeking to strengthen balance sheets.
Companies such as LeggMason Income & Growth and Dartmoor have raised new capital and in addition, a substantial number of companies have reduced their borrowings.
Notwithstanding these initiatives, a few companies have been forced to announce temporary suspensions of, or permanent reductions in, their dividends.
With the benefit of hindsight, it is now clear that some of the split structures launched in recent years involved too high a level of gearing, and especially bank borrowing, and that cross investment has compounded the sector's problems.
However, we believe that the basic rationale for splits remains valid: different investors have different needs and consequently it make sense to split off the different elements of the investment return from a portfolio and feed them to different classes of shareholder.
Against this background I believe that prudently structured and well-managed trusts should survive and in due course prosper.
Banks are working for investors.
Many splits will outperform.
Dividing returns benefits investors.
Breaching bank covenants.
Geared funds underperform.
Further significant market weakness.
Chris Whittingslow, managing director, Exeter Asset Management
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