Warrants poised for a revival

The Investment Column

Talk of booming equity markets this year has left warrant watchers cold. This neglected area of stock market investment has registered a fall of 15 per cent in 1995, according to Warrants Alert, a Bristol-based group that specialises in warrants.

The news may come as a surprise to many who see warrants as being almost synonymous with options - a highly-geared play on the underlying equities to which they are attached. Although there is a connection, the price of warrants is equally likely to be driven by supply and demand. In theory, the price of a warrant, essentially a tradeable option to buy a share at a specified price at some future date, should be easily determinable. Assuming the exercise price is below the share price, the warrant's value should reflect the difference plus an amount to represent the so-called "time value". This equates to the reduction in the carrying cost as a result of having control over the underlying share without having to put up the full share price.

So a warrant to subscribe at 500p when the shares are pounds 20 should trade at over pounds 15. But this year's performance, when shares soared in value and warrants sank, vividly illustrates that the reality can be very different from the theory when demand is lacking. Part of the problem stems from the preponderance of investment trust issues. Another is the importance of the private investor, many of whom are still licking their wounds after having been drawn to warrants by the boom in 1993, when the average price rose 220 per cent. The driver then was the upsurge in interest in emerging market investment trusts. This was fuelled by rises in shares and the attached warrants, boosted by hopes of new stock market miracles in Third World economies to rival the Tiger economies of the Pacific Rim. That dream turned sour after the Mexican debt crisis.

However, Andrew McHattie, of Warrants Alert, believes 1996 will see a reversal in the fortunes of the market, which he forecasts will rise 30 per cent next year. He argues that ratings are low in emerging markets like those of the Philippines and Taiwan, while general conditions look similar to those just before the boom in 1993 and 1994. Warrants in Schroder Asia Pacific Fund and in the previously underperforming Morgan Grenfell vehicle, the Overseas Investment Trust, are tipped as ripe to cash in on any rise in 1996. Meanwhile, after a recent fall, he also likes the look of the BTR 1997 series warrants.

While warrants are less volatile than traded options, there are still plenty of risks. Investors are not necessarily protected by buying warrants in safe, solid income stocks, as the Hanson chart illustrates. By contrast, the most money is often to be made in speculative plays like British Biotech, which now has the largest capitalisation warrants in the UK ahead of their expiry in January. The principle of caveat emptor - buyer beware - applies.