EXTRACT FROM AITC DIRECTOR GENERAL, DANIEL
GODFREY'S SPEECH TO DIRECTORS (FEBRUARY 2002)
As the Chairman commented in his opening address,
it is occasionally suggested that the AITC is in some way hostile
to splits or run in the interests of conventional trusts. The
truth of the matter is that we are very much in favour of all
uses of the investment trust structure that serve to benefit their
Indeed, the AITC has worked hard on behalf of
splits. As well as the work we've done with the media over the
past nine months, explaining splits and encouraging a more balanced
view, we have produced a guide to splits in Investment Week and
we are producing a consumer orientated splits guide in Bloomberg
Money in April, we are also producing a new factsheet, a new section
on the website and we are undertaking considerable IFA training.
We operate a splits marketing working group
and we have carried out a project to refine, define and simplify
the terms and jargon employed in the sector. The splits managers
analysts and professional advisers have been entirely supportive
of this process. So we are anything but hostile to splits.
However, with the benefit of hindsight, there
is no doubt that mistakes have been made over the past five years
and that this has led to some dramatic losses for investors and
a tarnishing of the name of the whole split capital sector. And
we have to hold our hands up and admit that the problems are not
just the result of unforeseeable behaviour by the markets or of
the reporting by the media. It has clearly been unrealistic for
new issues to seek to maintain real yields even as interest rates
were plummeting and equity yields falling. The inevitable reduction
of portfolio quality has played its part.
The practice of splits investing in splits has
led to gearing being piled onto gearing until it has become impossible
to get a handle on how geared some funds really are. The Association
has led an initiative to increase disclosure and transparency
for all affected funds not only those who are Members. This initiative,
supported by the FSA, is probably not the final destination but,
working with Boards and managers I am confident that we will work
our way to a better long-term disclosure structure.
There is a place for ungeared funds of funds
to provide diversification and professional management of a complex
product, but I am very unsure of the rationale for the geared
fund of funds. There is enough gearing and risk in the underlying
portfolio to make additional gearing unnecessary and if the large
majority of equity subscribers to these funds are other funds,
the impact is largely to costs on costs. The real external demand
has in fact been remarkably low when one considers the fact that
of nearly £2 billion of equity raised last year in split
issues, over two thirds of the money subscribed came from other
splits, and much of that as stock swaps rather than cash.
As for the other shareholders, there are a lot
of very worried zero holders out there, many of whom believed,
and were told, that were buying a low risk product. When they
see the risk ratings as assessed by professionals then re-classified
from lowest risk to highest risk, their complaints can hardly
be described as sour grapes resulting from financial loss.
To compound their problems, the introduction
of bank debt in front of zeros has pushed them over the cliff
much more rapidly when they become uncovered than used to be the
case in simpler structures and this additional risk was neither
understood nor explained until it went wrong.
Much money has been made out of splits over
the last few years; by brokers, fund managers, lawyers and accountants.
But the effect of unexpectedly poor markets and self-inflicted
mistakes has been disastrous for many priviate investors who stand
at the bottom supporting an inverted pyramid and has set back
the development of the split sector by a decade.
Furthermore, the AITC has constantly been told
that we're party poopers because we won't roll over and allow
all costs to be allocated to capital. We've seen trusts with portfolio
yields of 6 per cent allocating 80 per cent to capitalthis
means they are assuming a total return of 30 per cent from a portfolio
of bonds, high yielding shares and other splits! Ironically, some
of the more stretched trusts are now making their accounting policies
more conservative again so that they can bring down their payable
dividends to strengthen the balance sheet.
Remember, it is the Board not the manager or
still less the auditors, who are responsible for the preparation
of the accounts and the selection of accounting policies. I sometimes
wonder if the Board of a new trust is appointed when it is too
late to change the structure of the fund.
The AITC, the Managers, professional advisers,
bankers and regulators are all working co-operatively to ensure
the least painful outcome for shareholders of the various companies
that are experiencing difficulties. We are all absolutely committed
to restoring confidence and protecting shareholders' interests.
Splits should be a fantastic way of providing
solutions to a diverse range of financial planning problems, but
some of the practices of the recent past may have gone too far.
I like splits. I like what they can do and the way in which they
can be constructed to provide solutions to people's financing
planning needs. But the AITC will not act as an apologist for