Some capital shareholders might be in danger of not seeing any of their money returned due to the vo...
Some capital shareholders might be in danger of not seeing any of their money returned due to the volatile economic climate, according to Nick Brind, manager of the Exeter Capital Growth unit trust.
Brind believes many capital shares will find it hard to meet their repayment commitments if current economic conditions persist.
He said: "Some capital shares are reliant on price-earnings expansion in the market to provide growth. In a low inflation environment, nominal returns from equity markets will be lower and there is a greater chance that capital shares will be unable to meet their hurdle rates."
Brind added some capital shares have hurdle rates which mean they need to grow by as much as 3% pa before they will even break even.
He said: "Unless they can grow at this rate, capital shareholders will not even see their initial investment returned."
Brind also believes high yield commitments are forcing split capital trusts to take greater risks.
He said: "A number of split capital investment trusts have been launched which are facing very high yield commitments to their shareholders.
"To cope with this commitment they are very highly geared, some having levels of over 400%."
While this kind of heavy gearing would provide astonishing returns if the market goes up, Brind points out that the opposite is just as likely if the market falls.
According to Brind, cheaply available bank loans are encouraging fund managers to turn away from their traditional source of gearing, the zero dividend preference shareholder.
He said: "While zeroes demand about 9% annual return, bank debt can be picked up for about 7%."
However, should the ride be bumpy for the trust with high bank borrowings, covenants may be breached in which case large amounts of cash may have to be paid back on the loan.
Capital shareholders will be first in line when it comes to footing the bill, he said.
Brind stressed that good quality capital shares were still available, but emphasised the ability to find them was becoming increasingly important.
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