Dear Reader,
Investment trusts can be the perfect vehicle for private investors. The benefits can be significant: one-stop exposure to equities without the hassle, expense and dangers of picking individual shares, mouth watering discounts to asset value and superior yields. Add in that investment trusts can compound your gains free of tax and you have a compelling proposition.
Well – incredibly – the case for investment trusts just got even stronger. That’s because they can now issue a new type of share. It’s a development that few investors are aware of, but one that could let you profit spectacularly. I’m talking about ‘S–shares’, or to give them their full name, subscription shares. Let me explain…
How to get something for nothing
Subscription shares come into existence when investment trusts issue them for free to ordinary shareholders in proportion to their existing holdings. They’re allowed to issue up to 20% of their share capital in this way. So most issues give you one free subscription share for every five ordinary shares you already hold.
If the investment trust is unloved and its shares are trading at a big discount to net asset value (NAV), the subscription shares give shareholders something for nothing. It could boost the share price and narrow the discount to NAV...
Further down the line, these subscription shares can help the investment trust expand by bringing in additional capital. That’s because they give you the right (but not the obligation) to purchase new ordinary shares in the trust at specified future dates and at pre-determined prices.
In this respect, they are much like options. They offer the potential for magnified gains and losses compared with the underlying ordinary shares. But unlike options – which typically have a life of no more than three months – subscription shares can have a life of several years. This long lifespan sets them apart from options. It makes some subscription shares into valid long-term investment vehicles rather than mere speculations. And that can make them ideal for the growing band of private investors who, like you, are now discovering them.
Subscription shares are listed, so you can sell them straight away and pocket the cash bonus. Or you can hang on to them and watch them become more valuable if the shares of the underlying trust do well. But you don’t have to be a shareholder of the underlying investment trust in order to benefit. You could simply buy subscription shares in the market via your broker – exactly like any other share.
Let me give you an example of this strategy in action...
More excitement, lower cost and five long years to play with
JP Morgan Japanese Smaller Companies Investment Trust (JPS) issued subscription shares back in March 2009. They are now available to buy in the stock market by anyone who wants them. So let’s say you buy a few at around the current market price of 35p. What happens next?
Well, each subscription share is “exercisable” into one ordinary share of the underlying investment trust as follows:
Between 1 April 2009 and 31 March 2010 at 135p
Between 1 April 2010 and 31 March 2012 at 147p
Between 1 April 2012 and 31 March 2014 at 174p
Is it worth exercising? That depends on the prevailing share price of the underlying investment trust. For example, at the recent price of 120p, you would be mad to exercise. It’s not worth paying 135p when you could just buy a share in the market for 120p instead. The value of the subscription shares is therefore currently made up entirely of “time value” rather than “intrinsic value.”
And this time value is precisely what makes subscription shares so special. You see, timing is always the key to investment success…
What I mean is that if you buy a share too soon, your money can be lying fallow for years before your investment hunch comes to fruition. Buy too late, and you’ve missed the opportunity.
What is so amazing about the JPS subscription shares is that they give you five long years for the investment hunch – in this example a rise in the price of smaller Japanese companies – to come right. That’s an age longer than the life of spread bets, covered warrants, traded options or other derivative products. And if you lose patience in the interim, you are free to sell up and move on. Better still, it is a “geared” investment, so you can put down just a small stake for potentially big returns, and keep the rest of your money free to invest elsewhere. And unlike other derivative products, subscriptions shares can even be held in a tax free vehicle such as an ISA or SIPP.
What happens on expiry on 31 March 2014? On that day, the subscription shares will either expire worthless (if the underlying shares are below 174p) or – if the underlying shares are above the exercise price - you will receive cash of the difference.
In the intervening five years, the subscription shares give you an exciting “geared” play. That’s because instead of buying an ordinary share for 120p, you pay just 35p for the same underlying exposure. Your 35p outlay is just 29% of 120p, so your position is “geared” by a factor of just over three.
Look out for your next opportunity for free ‘S shares’
So, should the underlying shares advance by 10p from 120p to 130p, that would be a percentage gain of 8.3%. With expiry of the subscriptions shares still nearly five years distant, their time value would remain largely intact. They could therefore advance in tandem by 10p, giving a massive gain of 28.6% on your 35p outlay. Of course, moves in the opposite direction would be magnified too.
That’s why you should only take a small position in subscription shares, such that a total loss would not impact on your portfolio. If the investment is successful, the geared nature of subscription shares would still boost your portfolio’s value in the same proportion as your normal-size holdings.
There’s a rising flood of investment trusts that have issued these new subscription shares. Amongst them are Dunedin Smaller Companies (ticker: DNDL) and Perpetual Income & Growth (ticker: PLI), and a growing raft of investment trusts managed by JP Morgan. Spot the next trust to issue them, and you could be collecting your subscription shares for free.
These subscription shares could be a great opportunity for you to profit.
Good investing,
Andrew Vaughan
For The Right Side
Publisher’s Recommendation: Andrew Vaughan is the investment director of a discreet circle of investors called The Zurich Club. He’s just uncovered a little-known, low-risk strategy that can help you bank up to 37% extra yield by collecting “rent” on your stocks. Discover the “blue chip landlord” strategy here.
Note: Forecasts are not a reliable indicator of future results. Your capital is at risk when you invest in shares, never risk more than you can afford to lose. Please seek independent financial advice if necessary.
MARKET NOTES
No recovery for the housing market yet
BY SHIVVY ARORA
Today, Nationwide data showed a 0.9% rise in house prices for the month of June. But recent Land Registry figures paint a different picture of the housing market. What should you believe?
We think the Land Registry data is more believable. It bases its data on completed sales. And the so-called ‘stabilisation’ in prices as suggested by Nationwide and Halifax is only due to a drop in property supply corresponding to low buying activity.
House prices fell for a 13th straight month in May. First-time buyers are still finding it hard to get mortgages. Net lending has dived to its lowest recorded levels in 16 years, standing at a mere one-tenth of last year’s figures. And mortgage lenders aren’t going to ease their lending criteria anytime soon.
The chart below shows the Land Registry’s records of the average yearly change in residential property prices for England and Wales (green line) and London (yellow line) for the five years to May 2009. You can see the 15.9% drop compared to last year. And look how far they’ve nosedived from their mid-2007 peak.
Britain’s housing market remains weak
Source: Land Registry
The hits just keep on coming. The average number of property transactions between Dec-2008 and March-2009 have halved from a year earlier. Houses may be getting cheaper, but the recession and increasing unemployment means few buyers are taking advantage. And sellers continue to withdraw from the market.
We’re not buying in to headlines calling a housing market bottom. It’s merely the pace of decline that has slowed. The battered housing market is still in the doldrums.
We think house prices have further to fall. In fact, you could see as much as a 10% drop between now and mid-2010.
Brace yourself.
The Daily Reckoning –Bernie Madoff’s ordinary evil
BY BILL BONNER
London, England
Tuesday, 29 June 2009
Let the punishment fit the crime!
Poor Bernie. The man has been ordered to spend 150 years in the hoosegow. What for? Who did he kill? A century-and-a-half seems a little excessive for a financial crime. You could hold up three liquor stores and rape a whole convent and still not get 150 years. With a little good lawyering, a history of child abuse in the family and good behavior in the big house, you’d be back on the street in 18 months.
But all the papers seem delighted. “Locked up for Life!” says one of today’s headlines. The judge “threw the book at him,” says another. His victims wanted him to get no mercy. The judge gave him none, imposing the maximum sentence. He is “extraordinarily evil,” said the man on the bench.
Justice has been done. Right?
Here in the building with the gold balls, we’re not so sure. We stand up for lost causes, die hards and scalawags. Besides, we’re not convinced that Bernie is extraordinarily evil at all. He seems much more like an ordinary evil to us.
They say he defrauded investors out of $65 billion. The amount is unusual, but the crime is as common as income tax evasion. Who gets 150 years for evading income taxes? Heck, in civilized countries it’s not a crime at all – but a civil misdemeanor, subject to fine and retribution, not punishment.
But didn’t he lie to investors? Well, yes... he exaggerated the returns investors were likely to get from his fund. But if you put every fellow on Wall Street who does that in jail, you wouldn’t have any room for stick-up men and wife beaters.
Isn’t he the biggest financial scammer of all time? Well... he’s the title holder now. But he has a lot of competition close on his heels. Bernie’s crime was taking money from people under false pretenses... and then being unable to give it back to them. How is that different from the financing activities of the US government?
This year alone, the feds will borrow 50 times as much money has Bernie managed to take in during his whole 20-year career. They can only pay it back by borrowing even more money from more lenders. This is not very different from the typical “Ponzi” scheme, except that it if the government doing it. Eventually, the suckers are going to lose a lot of money.
And when you balance Bernie’s sins against his virtues, we’re not sure the man doesn’t come out at least as well as many of his accusers. While Bernie was pretending to make his investors rich, the SEC was pretending to protect them from Bernie. In fact, neither were really doing what they claimed. Which is to say, both are guilty of ordinary evil.
As we pointed out yesterday, nothing is as dangerous as good luck. Madoff was not extraordinarily evil; he was just extraordinarily lucky. He was plying his trade when the feds were pumping up the biggest financial bubble in history. No wonder so much hot gas came his way. His luck ran out when the bubble popped. And now a court has found him guilty of fraud and a judge has ordered him locked up for a period equal to roughly the time between the end of the US War Between the States and the resignation of Richard Nixon.
While Bernie is behind bars, the SEC and FED officials are still at large. Both are clearly guilty of dereliction and negligence.
But, what is the point of keeping Madoff in prison? He represents no threat. Rather than pay $30,000 per year to keep him locked up, we suggest that he be forced to do community service work. He should be pressed into service as the next head of the Federal Reserve after Ben Bernanke’s term expires in December.
With Madoff in the big office, there would be no longer any illusions about what sort of bank the Fed is running...
Read on...
To read the Daily Reckoning in full, click here.
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