During the early to mid 2000s, following problems in the "splits" market, we received large numbers of complaints involving split capital investment trusts. This note is based on our experience in dealing with those complaints. We do still receive complaints about these trusts, but the number has gone down significantly over the last few years.
"Investment trusts" are companies which invest in the stock market and issue their own shares, as investments in their own right, to the public. The idea is that investors' money is pooled and invested. Shares in investment trusts can then be freely bought and sold.
The big difference between investment trusts and unit trusts is that investment trusts are "closed" funds:
An open-ended investment company (OEIC) works in a similar way to a unit trust except that it is constituted as a limited company and issues its own shares. It is open-ended which means that when the demand for the shares rises the manager(s) can simply issue more shares.
The perceived advantage with an investment trust is that the manager(s) know the amount they have to invest and can work out the best strategy for that sum.
Another important difference is that unit trusts and OEICs are "collective investment schemes" and as such are regulated under The Financial Services Act 1986 and the Financial Services and Markets Act 2000.
Investment trusts are not deemed to be collective investments but are companies regulated by the Companies Act. This means that, whilst the Financial Ombudsman Service has jurisdiction over unit trust and OEIC managers, we do not have jurisdiction over investment trust managers or over the investment trust itself. See below for further information.
During an investment trust's life investors can sell shares via the market to others. Some investment trusts are set to be wound up on a pre-determined date and the monies divided up between the shareholders of the trust. The aim of all investment trusts is good returns for shareholders - as the market goes up.
In a normal or "conventional" investment trust, there is usually only one share class, called "ordinary shares". Split capital investment trusts - or "splits" as they are sometimes called - have more than one share class. There are variations, but the main options are:
In a rising market the fund pays out income on income shares. When it is wound up after a fixed period, depending on what type of shares they had, investors get fixed returns, return of capital or the rest of the value divided up.
In a falling market problems can occur. The most significant is that the trust may be due to end at a market low and there may not be enough value left to pay some or all of the shareholders.
Other problems we have seen involve "splits" deciding that as well as investing the funds subscribed to them, they would also take out loans to provide more working capital - so they could buy more investments. These loans were often tied to a default value - so if the overall value of the investments dropped below a certain level, the loans must be repaid or renegotiated.
Some "splits" invested heavily in other investment trusts. This led to a situation where the fall in value of one "split's" investments reduced the value of another's, and so on. Sometimes the other investment trusts had also borrowed to invest.
In the cases we see, consumers often say that:
"Splits" are not regulated by the FSA and the "splits" themselves are outside our jurisdiction. So we could not deal with a complaint about, for example, the management of a "split". But complaints that we can consider include those where regulated financial firms, such as advisers and investment managers, have advised on investments in "splits" or in products including "splits".
If the complaint is one that we can consider we will examine how much knowledge the financial business had about the risks associated with investments in "splits". This helps us to decide whether its advice was suitable - the more knowledge the financial business had, the more likely we are to think its advice should have taken account of the real risks of the particular investment in "splits" which it was recommending.
We would expect the level of knowledge to vary between financial businesses. For example, we would expect the financial business that promoted and managed the "split" to have more knowledge than an independent financial adviser. We would also expect a financial business's knowledge to vary over time, as the real risks of investing in "splits" became better known. For example, we would expect an independent financial adviser to have more knowledge about "splits" in, say, 2001 compared with in 1997.
We will also examine the exact structure of the "split" and how it evolved to decide whether it properly reflected the investor's attitude to risk.
contact our technical advice desk on 020 7964 1400
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