Splits started in the 1970s and were originally the preserve of sophisticated investors but Russ Mould, investment research director of AJ Bell, says the equity bull run of the 1990s encouraged some clients to look at them and also fund groups to seek a wider audience for them.
Some money management institutions sold split-cap investment companies as relatively safe investments but Mr Mould says they then began to believe their own press releases and took on additional risk themselves.
He says some splits borrowed money to invest in the market, a standard practice known as ‘gearing’ that is still used by many investment trusts to this day, but the timing proved poor as the UK equity market peaked in late 1999.
The gearing magnified the losses suffered as share prices fell and Mr Mould says the effects were compounded by how split-caps had bought shares in each other, a tactic which led to allegations they had colluded to try and support the market.
Upon wind-up, Mr Mould says several splits were found to be worthless and tens of thousands of investors were left out of pocket.
In the early 2000s around 50 split capital companies became bankrupt and there was an FSA investigation into what had happened.
Many of the splits suffering problems had introduced considerable amounts of bank debt (financial gearing) into their structure, according to Annabel Brodie-Smith, communications director of the Association of Investment Companies.
Also Ms Brodie-Smith says at a time when interest rates were coming down, some splits invested in other split capital companies in order to maintain high yields – and some investee companies in turn invested back in the company that had made the original investment.
This meant that these splits were exposed to financial gearing and their portfolios were highly geared from the circularity of investment, Ms Brodie-Smith says.
So when there was a loss of confidence in the market Ms Brodie-Smith says these highly geared vehicles became bankrupt.
In November 2003 changes to the investment trust listing rules and conduct of business of rules were introduced.
Ms Brodie-Smith says the changes meant that the circularity of investment (investing in splits that arose so damagingly when split trusts invested in each other) could not happen again.
Split capital investment trusts, like all investment companies, are not currently regulated by the FCA, but by company law and the UK Listing rules.
