Zero Dividend Preference Shares Zero dividend preference shares are a very useful tool in financial planning for individuals. Although they are not guaranteed zero dividend preference shares offer a predetermined sum at the end of the investment term. A zero dividend preference share as the name implies does not provide a dividend payment. The return over the life of the shares arise from the increase in its’ value to maturity. Zeros are issued by split capital investment trusts. These trusts issue different classes of capital with different rights attaching to them - normally a combination of income shares, capital shares and zero dividend preference shares. Because individual investors have different investment requirements the different classes of shares appeal to different investors. One investor may prefer to capitalise on income with little regard for any residual value, another may prefer steady growth via zeros whereas another might be tempted by the offer of high risk high reward available from capital shares. Splits can cater for all these requirements and even more specialised forms of investment if required. Investors can, if they wish, buy packaged units which provides them with exposure to all the underlying share classes. Returning to zeros, although they are the least risky type of split capital investment trust shares they are not without risk. However it is claimed that since zero's were invented some 20 years ago all issues have been paid in full and on time as they have come up to their maturity date. For most of the current zeros there would need to be very extreme negative market conditions for full repayment not to take place. Zeros offer a fixed capital sum which is paid at a specific time in the future. Based on the current price, the redemption price and the period to redemption a gross redemption yield (GRY) can be calculated. The calculated GRY can then be compared with other investment returns, typically gilt edged securities, to determine relative value. An example will illustrate the point:- Exeter Smaller Companies Spilt Capital Trust (EXAMPLE ONLY NOT ACTUAL FIGURES) Current Price 101.75p Redemption value 183.24p in 3 years time Redemption yield 8.85% Other important figures are the Cover and Hurdle rate- Cover - this represents the extent to which the final redemption value is covered by the current assets of the trust. In the case of this trust the cover is 1.4x final value, the underlying investment portfolio could fall by some 39.4% over the remaining life of the trust and the zeros would still be paid in full. Hurdle rate - This is linked to the cover and indicates that the underlying investment assets could fall by 4.86% per annum between now and final maturity and the zeros would sill be paid out in full. Zeros are attractive to low risk investors because they provide predictable returns. They are less volatile than conventional shares and there is the comfort of knowing that there is a predetermined redemption price at maturity. Zeros are also attractive investment vehicles in a period of low interest rates and investment yields generally. It must be remembered however that they are interest rate sensitive and if interest rates were to rise, zeros would not perform particularly well and of course the final payout is not guaranteed. Because the growth in the value of zeros is treated as capital gains and not income, they are attractive to investors who want to avoid income tax and capital gains. An investor can avoid tax by withdrawing up to their capital gains tax limit - currently £7,200 for an individual each tax year. Investment in zeros can either be in a collective fund or direct in the stockmarket. Zeros need not be held until maturity but can be traded to take advantage of any pricing anomolies that may arise. A portfolio of zeros can be used to produce income by selling shares to crystallise profits and releasing funds for distribution. Overall they are a very useful tool in the investment armoury and can be used to balance a portfolio of higher risk investments.

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