High earners are buying into the new zero-dividend preference shares (zeros) being issued by investment trusts, say advisers, as they seek more tax-efficient ways to generate lump sums for future needs, such as school fees.

This week, Electra Private Equity became the latest trust to list new zeros on the London Stock Exchange. Each share offers a final capital entitlement of 155.41p in seven year’s time – a redemption yield of 6.5 per cent a year, based on the 100p issue price. Last month, Ecofin – the £300m specialist trust that invests in water and power companies – issued new zeros offering a 7 per cent redemption yield on the issue price.

Since then, however, the price of these zeros has quickly been driven up, as investors bought in the market. “Ecofin zero dividends came to market last Wednesday at £1 and today trade at 106.5p, highlighting the demand for these,” said broker Killik & Co. JP Morgan Private Equity and Utilico have also listed new zeros this year.

Much of this demand is being driven by zeros’ increased tax advantages, following changes to income tax rates announced in the Budget. Zeros pay no income, but return a defined capital sum provided it can be fully ‘covered’ by the trusts’ assets. As a result, holders of zeros are liable only to capital gains tax at 18 per cent, rather than income tax, which rises to 50 per cent for those earning £150,000 or more from April 2010.

Killik & Co calculates that the potential tax saving for someone investing £10,000 in the Electra zeros, compared with an investment liable to income tax, will rise from £1,472 to £2,033 over seven years.

Recently issued zeros have better asset backing than those issued by the scandal-hit split-capital investment trusts ten years ago, in which investors lost up to £620m. Electra’s zeros are covered 7.1 times by its latest net asset value, and Ecofin’s zeros were 4.5 times covered at the time of issue. Back in 2000, cover was often as low as 2 times asset value.

“Most of the problems with the asset class back then were due to two factors,” said Adrian Lowcock, senior investment adviser at Bestinvest. “There was miss-selling, and the splits were a house of cards investing in each other. But now the tax opportunity is coming back, and lessons have been learned from what happened there.”

Killik & Co favours the Utilico zeros for high-earning lower risk investors, as its “hurdle rate” – the amount the assets would have to grow for the zeros to be redeemed in full – is minus 25 per cent. “Utilico 2012 is very well covered, has a management team that is reasonably well invested in the ordinary equity, and would have to lose all its capital before the zeros were compromised,” said Killik’s head of research, Mick Gilligan.

He recommends zeros for investors who have a known liability 5-7 years in the future. “A classic use is school fees for somebody who doesn’t want to take too much risk. Historically, they would put money into National Savings, in the bank, or a gilt – but, effectively, the compounding effect is eroded by tax take on that income.”

But potential investors are warned to keep track of the redemption yield, cover ratio and hurdle rate, as these change as zeros trade on the stock market. “You need to look at what’s going on with each issue – continual vigilance,” advised Lowcock. “Compare the net asset value and redemption value at the time of purchasing.”