09: Zero dividend preference shares

Traditionally, zeros were normally used to generate a relatively secure and predictable capital gains for investors. However, the structure of some of the investment trust issues of the late 1990s and beyond was more highly geared, creating a greater risk of a shortfall at maturity. In the first half of the current decade several zeros fell well short and some investment trusts were forced into liquidation, leaving little or nothing for their zero holders.

The zeros have redemption dates, a predetermined rate of return, and participate in the capital performance but not the income of the investment trust.

The redemption price is the final redemption value of the zero at the liquidation date. Zeros are issued at an initial asset value rising by a compound growth rate to the final value.

Zeros are taxed as capital and not income, and may be attractive to investors not subject to capital gains tax, or those who use the annual capital gains tax exemption.

Zeros were once regarded as low risk investments because little or no growth from the trusts was needed to cover the final redemption price and the shares had a prior equity charge on the available assets. However, the zeros in some highly geared split capital trusts proved to be anything but low risk, because the zero shareholders ranked behind lenders who were prepared to force the trust to wind up or restructure when covenants were breached.Last Updated