However, what I often come across is private investors holding such warrants without having a full understanding of their significance.
One of my established clients, Mr Knowles, has quite an extensive equity portfolio, in excess of pounds 200,000. Some of the purchases were advised by myself, and others he has purchased himself without any consultation. Mr Knowles received a letter concerning his holding in the Mercury European Privatisation Trust. The letter asked whether he would like to exercise his warrants in their European Privatisation Investment Trust. "Should I do it, and what is it all about anyway?" Mr Knowles questioned, adding that he had a number of warrants in his portfolio, all of which had come free with investment trust launches.
I asked him whether he had purchased any more, or sold any of them, and he said no - he had just let them be. He had noticed, however, that they had gone up in value quite a lot over the past 12 months.
I explained that warrants carry a high risk and that, in simple terms, they give you the right to buy the underlying share at a set price, in this case pounds 1. The current price of Mercury European Privatisation shares is pounds 1.84.
When I pointed this out to Mr Knowles, his comment was: "Excellent - that means that I can invest pounds 1 and promptly sell it for pounds 1.84." I confirmed that he could indeed do this. But I then explained that in order to purchase the Mercury European Privatisation shares at pounds 1, he had to give up the right to his warrants, which were valued at 95p.
"I give up 95p and pay pounds 1 for the new shares which I can then sell at pounds 1.84," Mr Knowles mused. "Correct," I replied. "But that means I lose money!" Mr Knowles exclaimed. "Correct," I confirmed.
Mr Knowles then realised that exercising these warrants is not such a good deal after all, and was keen for me to offer some guidance. "Sell the warrants," was my advice, "and you receive 98p each, and that is the end of the matter."
"But what if I do not want to sell them? They have done exceptionally well over the past year," said Mr Knowles.
"You can leave them, but they have a limited life, in this case six years, and you must not forget they are high-risk and can be volatile. If you are not happy with that then you are probably best selling," was my response.
Despite the large size of Mr Knowles' portfolio, he is a cautious investor and decided that he would sell the warrants, along with the others he held, all of which have done well.
Having decided to sell the warrants, Mr Knowles wanted to find a home for the money. He is by nature a deeply cautious investor, so by combining the sale proceeds from the warrants with some additional cash Mr Knowles wished to invest, we concluded that a with-profits bond was the best option.
Mr Knowles then asked which one would be best to use, because he already holds a number of such bonds and was keen to spread his money with other companies to lower risk even further.
I suggested Scottish Widows, who are relatively new to the with-profit bond market. They only started to provide bonds back in November 1995 but had produced a very satisfactory annual return of just over 10 per cent per annum. For many clients, 10 per cent is a magic figure.
Mr Knowles said that this was better than the building society, with a risk profile not much greater.
He then asked: "Why Scottish Widows?"
I replied: "They are one of the oldest and best life companies around, with an excellent record. They are dynamic and their level of service is excellent."
"What are their charges like?" asked Mr Knowles.
"There is a 5 per cent bid-offer spread but, as you are investing pounds 25,000, they enhance your allocation by 2.5 per cent. So the cost to you is 2.5 per cent."
Mr Knowles is always looking for a deal when he invests his money, and as he is a long-established client we are more than happy to agree, so I offered him a 2.5 per cent discount, meaning that the cost of buying the bond had been reduced to zero.
By the end of the telephone conversation, we had lowered Mr Knowles's risk profile, and sorted out his confusion over his warrants, and put the money into a high-quality, low-risk, with-profit bond at no cost.
Tim Cockerill is managing director of Whitechurch Securities, independent financial advisers, 14 Gloucester Road, Bristol BS7 8AE (0117 944 2266)Reuse content