Can I do that?
There are a growing range of
internally geared products that allow investors to get
all the benefits (and risks) of leverage without actually
having to take out a loan. The products you're most
likely to come across are instalment warrants and
geared share funds. Both have a level of borrowings
built into their structure, which increases the potential
risks and rewards for investors.
How do they work?
Did you invest in T2, the second
public offering of Telstra? Well, apart from learning a
valuable lesson about how there's no such thing as
a sure thing, you will have also learnt the basics of
how instalment warrants work.As with T2, you pay a
proportion of the share price upfront to buy the
warrant, and at a later date you can pay the balance
of the share price to convert your investment to
ordinary shares.You receive the full dividend on the
shares even though you have paid only a fraction of
the share price.
The major difference between T2 and
instalment warrants is that the Federal
Government issued warrants in T2 while
instalment warrants are issued by financial
institutions over a wide range of listed companies.
The Australian Stock Exchange says most
instalment warrants are structured so that you pay
20 to 50 per cent of the share price upfront.The
second payment will include costs and "interest" on
your "loan" – which may be tax-deductible.
At the end of the warrant term, you can generally
make the second payment and convert your
warrants to shares, allow the warrant to lapse, or
roll it over into a new warrant.
So-called high-yield instalments are more highly
geared and consequently offer a higher level of risk
and return. (Other types of warrants include trading
warrants, which offer leverage to short-term traders
and endowment warrants – a long-term investment
where the dividends on your shares are directed
towards your final payment.)
Internally geared share funds are offered by a
number of fund managers including Colonial First
State, Macquarie, Advance and MLC.These funds
borrow money to supplement the investments
made by unit holders and the interest on the loan is
generally paid out of the fund's earnings.
Most funds have conservative debt levels so that
the interest costs do not exceed the income
received by the fund.However, geared share funds
are likely to provide less income (but hopefully
more growth) than regular share funds because of
this interest cost.
How do I invest?
Warrants can be bought direct
from the issuer via a prospectus or "second hand"
on the sharemarket through an ordinary broker.
The Australian Stock Exchange is the best place to
start.It has courses on warrants trading and
detailed information (including the names of all
issuers) on its website at www.asx.com.au (go to
the ASX Markets link).
Internally geared share funds are offered through
a prospectus in the same way as other managed
investments.Talk to your adviser or go through
a discount broker offering cheaper entry to
managed funds.
Each week financial advisor Noel Whittaker answers your
questions.
