Warrants oil wheels of investment trusts: The right to buy future shares at a fixed price is a growing perk
Sunday 13 February 1994
Private investors who subscribe for shares in new investment trusts like these will find that as part of the deal, they are likely to get a bundle of warrants. Rather like the freebie alarm clock or pocket calculator thrown in by an encyclopaedia salesman, warrants may seem a nice enough bonus but not necessarily what you would choose to go out and buy. What do you do with them?
Investment trusts are an essentially simple idea that the industry has turned into a sophisticated financial device - or, put another way, has made hideously complicated. Investment trusts are companies set up with the objective of putting their own funds into other shares or other investments. As with other types of collective investment, the investment trust shareholder hopes to gain both from a wider spread of investments and from fund management.
Investment trust shares are bought and sold on the stock market, and while the market price reflects broadly the overall assets held, investment trust shares have traditionally traded at a discount - that is, at less than the book value of the assets divided by the number of shares. This poses a potential problem when new investment trusts are launched, particularly since start-up costs are typically about 4 per cent of the capital subscribed. This might suggest that anyone buying shares in a new issue would immediately see their investment value fall by 4 per cent, even before the discount is taken into account.
The warrant is a convenient device that provides subscribers with an additional perk, the opportunity to benefit in the future when, all being well, the investment trust has become well-established. It gives holders the right - although not an obligation - to buy investment trust shares at a future date or dates and at a fixed price.
Investment trust warrants have become increasingly popular since the early Eighties. 'There's no doubt that the warrant has proved a successful financial engineering tool,' says Hamish Buchan, director of NatWest Securities. 'It's the Vaseline which oils the wheels.'
Warrants are bought and sold in the market, though the volume of trading can be small and bid/offer spreads may correspondingly be wide. The market price of warrants also tends to fluctuate, sometimes wildly. This is what the Association of Investment Trust Companies describes as the 'element of excitement warrants can offer'.
Essentially, whether they know it or not, holders of warrants are playing the traded options game. With options the purchaser buys the right to buy or sell a particular share at a particular price before a set date. Warrants also offer investors the chance to benefit from share price movements without having to pay the full cost of the shares themselves - the possibility of large gains for a small stake. But the right to buy shares is only exercisable at a set date or dates.
Investors with warrants who do not want to actively play the market have the choice of selling them or hanging on until the time comes to use them to buy shares - what is called 'exercising' the warrant. Obviously, this is only worthwhile if the share price at the time is above the offer level (when the warrant is said to be 'in the money'). Shares bought when exercising a warrant must be paid for in full but stamp duty and brokers' commissions are avoided.
The extra paperwork of keeping warrants means that some people choose to sell them immediately a new issue comes to market. 'A lot of people just sit on them though,' says John Korwin-Szymanowski of SG Warburg Securities. As he notes, it is important not to forget entirely about them: while some investment trust companies have powers to ensure that investors who forget to exercise their warrants can still benefit, others do not.
Colin McLean, managing director of Scottish Value Management, identifies a seemingly unlikely role for warrants. 'Some people will put warrants in children's portfolios,' he says. 'It's often thought that investments for children should be low-risk, but if people are not too concerned about the volatility, warrants have the advantage that they do not pay out interest.' Inland Revenue rules say that if interest on children's investments given them by parents is more than pounds 100 a year, it must be taxed with the parents' income.
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