Collins Stewart sees NAV increase for fund of zeros

Launched the day the FSA began its investigations into the split capital trust sector, the Collins Stewart Zero Dividend Recovery Fund has seen its NAV rise by approximately 6.78% to May 30.

The fund, managed by John Davey, launched on 11 April with an NAV of 96p, six weeks later, as at 30 May the NAV had risen to 102.5p.

Davey said that while all the press comment on splits has been broadly negative, there has in fact been a powerful rally taking place in the splits sector, which he said is down to short-term technical reasons and long-term structural reasons.

He added: 'Stocks fell to low valuations in March and April this year when many private clients were scared out of holding zeros, so with not much stock about it does not take much buying to get these prices back up and turn this area of the market.'

The long-term structural reasons for a recovery in zeros, said Davey, is that the boards of split capital investment trusts are now starting to do the correct things concerning them, for instance cutting dividends, buying-back zeros and charging accounting policies to revenue not capital. All these changes, said Davey, are positive for zeros. Collins Stewart is currently holding 23 zeros in the portfolio and the group believes there is still extreme value in many zeros. The trust is presently 85% invested. The portfolio is split into three categories. Category A, which originally comprised 50% of the portfolio, now accounts for 40%. This category invests in zeros that have an asset cover greater than one, have attractive yields and reasonably good asset quality.

A zero Davey likes in this category is Royal London UK Equity & Income, which has a gross redemption yield (GRY) of about 11.6% and is covered 1.15 times. Davey said that even if the splits sector is written down by 25% this zero will remain covered, so he believes it represents excellent value.

Category B now accounts for 50% of the portfolio, after originally only making up 25%. It invests in zeros that are uncovered, what Davey called the 'walking wounded,' which still have a chance of paying back if directors take the right actions. These are currently yielding between 15%-20%.

Britannic UK Income is an example of a zero in category B that Davey likes at present. It has a GRY of 18.7% and a 0.95 cover, he said that although it would not pay out in full if the splits sector was written down 25%, he would still get a chunky yield back on it.

The final category, category C, now makes up about 9% of the portfolio, after also launching at 25%. It invests in zeros with yields of between 100% and 200%. Davey said that while these zeros are never likely pay back their redemptions in full, he might be able to get quick positive returns if there is any sort of corporate activity.

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