Introduction

Investment trusts offer a structured approach to portfolio management. One variation, the split-capital investment trust, introduces a dual-share structure that caters to different risk appetites. In this guide, I will explain how split-capital investment trusts work, their advantages and disadvantages, their role in portfolio diversification, and key considerations before investing.

What Is a Split-Capital Investment Trust?

A split-capital investment trust issues more than one type of share, allowing investors to choose between income-focused and growth-focused options. Unlike traditional investment trusts that issue ordinary shares, split-capital trusts create different share classes with distinct financial characteristics.

Types of Shares in Split-Capital Trusts

Share Type	Characteristics
Zero Dividend Preference (ZDP) Shares	Offer fixed capital growth without dividends.
Income Shares	Provide high dividend payouts, often at the cost of capital growth.
Capital Shares	Prioritize capital growth with high risk, receiving residual value after other shares are settled.
Ordinary Shares	Balance income and capital growth, usually with voting rights.

Mathematical Representation of Returns

Investors evaluate potential returns using expected values based on share type characteristics. If an investment trust has total assets of A and liabilities of L , then the net asset value (NAV) per share is given by:

NAV = \frac{A - L}{N}

where:

• N is the number of outstanding shares.
• A represents total assets, including portfolio holdings.
• L represents total liabilities, including debt and obligations.

For ZDP shares, the expected value at maturity is:

P_{ZDP} = P_0 (1 + r)^t

where:

• P_{ZDP} is the maturity value.
• P_0 is the initial purchase price.
• r is the implied growth rate.
• t is the time to maturity.

Advantages of Split-Capital Investment Trusts

Split-capital trusts cater to various investor goals. Below are key benefits:

Advantage	Description
Customization	Investors can select shares matching their risk profile.
Tax Efficiency	ZDP shares avoid dividend taxation, benefiting tax-sensitive investors.
Diversification	The structure allows both income and growth strategies.
Managed Risk	ZDP holders receive priority repayment, reducing default risk.

Risks Associated with Split-Capital Investment Trusts

Despite their advantages, split-capital investment trusts pose risks:

1. Leverage Exposure: Some trusts borrow funds to amplify returns, increasing financial instability.
2. Market Fluctuations: Volatility in asset prices affects NAV, impacting share values.
3. Dividend Variability: Income shares rely on portfolio yield, which may fluctuate.

Comparison: Split-Capital vs. Traditional Investment Trusts

Feature	Split-Capital Trusts	Traditional Investment Trusts
Share Types	Multiple share classes	Single share type
Income Options	Customizable based on share type	Fixed for all shareholders
Risk Levels	Vary by share class	Uniform across all shares

Example Calculation: Expected Return

Consider an investment trust with total assets of $100 million and liabilities of $20 million. If it issues 5 million ordinary shares and 2 million ZDP shares, the NAV per share is:

NAV = \frac{100M - 20M}{5M + 2M} = \frac{80M}{7M} = 11.43

If a ZDP share has an initial value of $8 and compounds at 5% annually for 5 years, the maturity value is:

P_{ZDP} = 8 (1.05)^5 = 10.21

Conclusion

Split-capital investment trusts provide an alternative structure for investors with specific financial goals. Their ability to separate income and growth streams makes them attractive, but the added complexity requires careful evaluation. By understanding how different share classes function and assessing risk factors, I can make informed decisions when considering split-capital investment trusts in my portfolio.