Split capital investment trusts

Back around 1990, I became interested in investment trusts - specifically split capital investment trusts. These have a complicated share structure that, in the best cases, can generate profits in different ways, thereby satisfying different kinds of investors. The main split is between capital and income shares. Depending on an investor's tax status, it may be preferable to receive profits as either income or to let them accumulate as capital.

The shares have an order of priority when winding down the trust, and it is this angle that amused me, as I recall analysing some trusts that had an obvious bias towards particular shareholders! Now, this reminds me a bit of setting up investment vehicles using smart contracts. Some quite complex structures have emerged - one obvious one is Olympus DAO - and the investor has to be aware of their place in that structure, and the optimal strategy to extract profits.

The thing I wish to look at are the income shares. There are three slightly different types, with different levels of capital protection. But, in essence, they all do the same thing: turn capital and profits into income, usually paid monthly. This makes sense if a trust is primarily invested in bonds, but it can also be used to create interesting effects!

Let's take one simple example: imagine you buy 100 income shares at $1, and they are designed to produce a fixed 10% income per month for 12 months, with no capital protection. In the end, you have made a 20% profit, all paid out in cash, and your income shares are now worth zero. (The real calculation is more complex, as part of your capital has been returned, but let's not go there for now!) If you had bought 100 capital shares, then those shares might be worth $1.20 each, giving the same profit at the end of the year. However, notice that such capital shares are at the bottom of the pecking order in terms of entitlement. It is possible that all those income shares have disbursed a large part of the profits, thereby leaving the capital shares with the crumbs at the end! Lots of different scenarios can play out, depending on the performance of the underlying assets and the precise rules of each share type.

If we look back at the founding of the BYT program, you may now see some similarities with an investment trust structure. I had considered creating two tokens - one for capital, the other for income - but given the uncertain level of defi knowledge of the community, I thought it would just complicate matters. However, BYT is a combined income-plus-capital token and can be traded and held for both reasons.

All of this will become relevant very soon.