The A to Z of 'C' shares

Ken Nicholson explains the advantages of a cheap, effective way of fund-raising
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Temit, Templeton's Emerging Market Investment Trust Britain's best-performing investment trust, with a 393 per cent all-in growth since it was launched in July 1989. Its 400 million shares now stand at 138p each. It is now raising an additional pounds 100m to increase its investment capacity by issuing 100 million new 'C' shares, plus warrants at 100p a share.

Merrill Lynch is placing 84.5 million shares and 15.5 million are being offered to existing investors and the general public. Applications are required by 6 June.

Investment trusts, after decades of slumber, have sprung to life in the past five years or so. Increasingly private investors are attracted to investment trusts to gain the benefits of equity investment, diversification and professional management, and avoid the 5 per cent spread between bid and offer prices which apply to unit trusts.

A potent factor behind this resurgence has been the introduction of savings schemes, pioneered by Foreign & Colonial in 1984. But the birth of the 'C' share in 1991 has also played its part.

'C' shares are an effective way for an investment trust to raise new assets and to allow investors to subscribe for new shares without adversely affecting the interests of existing shareholders.

Investment trusts are sometimes referred to as closed-end funds because they have a fixed number of shares in issue and the price is determined by supply and demand for the shares. This contrasts with open-end funds, like unit trusts, where the manager will create new units to accommodate new investors at a price equal to the net asset value of the underlying assets.

But a closed-end fund isn't always closed. New share issues can take place and when they do it is usually through issuing 'C' shares or conversion shares. 'C' shares are a relatively recent innovation. The first issue, by Aberforth Smaller Companies, only took place in December 1991, This was followed soon after, in April 1992, by an issue of 'C' shares in Templeton Emerging Markets Investment Trust. Since then 'C' shares have become the standard way for investment trusts to raise fresh capital as the chart below illustrates vividly:

Generally there needs to be a demand for the new shares. A sign that there is strong demand is if the existing shares trade at a premium to net asset value.

This shows that investors are willing to pay more for the shares than the current value of the assets backing them in the belief that the shares will produce strong performance in the future.

When an investment trust wants to raise new money however, there will inevitably be a period when the bulk of the money raised sits as cash, uninvested. If all the assets of the investment trust were lumped together this could mean there would be substantial dilution for existing shareholders: if the market rose quickly then they would underperform simply because of the large cash element.

Keeping the money in 'C' shares avoids this as they are kept in a separate pools of assets until the bulk of the money is invested, when they then convert to ordinary shares.

Prior to the introduction of 'C' shares fresh capital for investment trusts had to be raised through a rights issue or placing at a fixed price. This set price obviously had to be at a discount to the existing share price to attract new money. But there was a risk that if market movements during the offer period took the share price below the fixed-offer price then nobody would participate in the offer.

'C' shares get round this by adding an initial price, usually 100p, and converting at a later date to ordinary shares on the basis of respective net assets.

For example, if the ordinary shares had a net asset value of 300p and the 'C' shares had an asset value of 100p, then each 'C' shareholder would receive one ordinary share for every three 'C' shares held.

How does it affect existing investors?

The 'C' share route is fairer to existing shareholders because the full expenses of raising additional capital is borne by the 'C' share assets and not the combined assets as was the case in more traditional forms of capital raisings.

Usually the expenses of the issue are capped at around 4.5 per cent to ensure that the opening net asset value per share is no less than 95.5p per 100p share.

Existing holders are usually given priority in the event of any scaling- back of applications for 'C' share issues.

The increased liquidity in the company's shares, the spreading of fixed costs across a wider asset base and the ability of the fund manager to buy new investments without first having to bear the cost of selling existing holdings can also benefit existing shareholders.

Should I invest in 'C' shares?

The main question that you should answer is do you want to increase your exposure to the particular investment concerned. If you have neither the money nor inclination to invest any more, then the offer can be ignored.

However if you are satisfied with the performance and are happy to invest more, then 'C' shares may be a good way to increase your exposure, particularly if the existing shares trade at a sizeable premium.

It can also sometimes be more cost-effective to participate in a'C' share offer, whether you are an existing investor or a new one, as you avoid having to pay stockbrokers' commission on your investment.

Ken Nicholson is a fund manager at Templeton Investment Management.

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