Get the right share for you
A whole host of different share classes - some you may have heard of, others that sound strange and complicated - pepper the reports on how companies are trying to dig themselves out of the recession-shaped hole they face.
For example, the government snapped up £5 billion worth of preference shares in Royal Bank of Scotland last year.
And the banks that propped up fading fund manager New Star before they sold it on owned 94% of the new convertible redeemable preference shares that were issued by the fund management firm.
While you may have heard of ordinary shares and preference shares, there is a massive range of structures that companies can put together to raise capital.
Joss Alcraft, a partner at legal firm Matthew Arnold & Baldwin, says: "Classes of share tend to be either ordinary or preference shares and/or be denoted by a letter.
For example, a company's share capital may consist of A ordinary shares, B ordinary shares and C ordinary shares, each with different rights attached to them."
Investors may also be offered redeemable, convertible bonds, convertible preference, deferred and warrants.
Most UK companies have just one class of share nowadays, but it wasn't always that way. Richard Beddard, companies and markets editor of Interactive Investor, recalls: "Decades ago, unconventional share classes were more common at companies like Whitbread and Young's.
"Investing in non-voting shares was the norm. Many people owned Young's shares for the perks that came with ownership; one of which was a seat at the AGM - a massive knees up."
However, as companies scramble to get more cash from investors and struggle to keep afloat in the economic turmoil, unconventional share classes are starting to crop up again. Let's examine some of the different types that you could be offered or might read about.
First up, preference shares. These have been in the news a lot, as the government owns billions of pounds worth of preference shares in some of the UK's biggest banks. This has upset their shareholders, as it means the government will get first dibs on dividends in future.
Preference shares are often called low-risk shares, as they give first rights to a dividend ahead of ordinary shareholders, which is useful in bad times. They also rank ahead of ordinary shareholders if the business is wound up. But the dividend is usually fixed and they never share in the growth of the company.
According to Alcraft, another potential downside is that preference shares are usually non-voting - the holder cannot vote at shareholder meetings.
Next, deferred shares. These simply mean that holders of deferred shares will be entitled to a dividend only after a certain date or if profits exceed a certain amount.
Financial website moneyterms.co.uk says they can be seen as the opposite of preferred shares, as they rank lower for capital repayment in the event of insolvency.
Certainty plus flexibility
Convertible shares are another type of share class. These are preference shares that can be converted into normal ordinary shares at a preset date and price.
"These combine the advantages of preference shares and ordinary shares," observes Michelle Gibbs, financial planner for IFA firm Helm Godfrey. "Shareholders get the certainty of fixed returns, but also the right to convert to ordinary shares."
According to Adrian Lowcock, senior investment adviser at Bestinvest, convertible shares don't cost the company any money to issue, but act as a sweetener when issuing preference shares.However, he warns: "The disadvantage for existing ordinary shareholders is a potential dilution of their equity stake.
"Also, if the company share price doesn't reach a certain - usually high - price, the conversion rights are worthless. Convertible shares don't usually trade at levels where it is worth converting them."
You may also have come across the convertible share's cousin: the convertible bond. As you would expect, these are bonds that can be turned into ordinary shares.
According to investment house F&C, convertible bonds have undergone a surge in popularity in recent years. Global issuance of convertible bonds hit a record level of $200 billion (£125 billion) in 2007.
James Davies, investment research manager at Chartwell, says: "Convertibles can yield more than high-yield bonds, even though, in many instances, they are issued by investment-grade companies.
Such opportunities don't occur very often, but it's worth considering that the price of convertibles is influenced by the price of the underlying equity and its volatility so don't be fooled into thinking that the bond part of the name means that convertibles are low risk."
The M&G Global Convertibles fund is one of the few UK-domiciled funds that offer pure exposure to this asset class and it has returned 29% over the past year.
The FSA-recognised F&C Global Convertible Bond (euro-hedged), a Luxembourg-domiciled fund, has delivered 19% since October last year.
The final share class worth mentioning is the warrant. These give the holder the right to purchase shares in the company at a specific price at a future date. Warrants are tradable in their own right, and their value will go up and down as the price of the underlying shares fluctuates.
"Warrants are highly geared to the ordinary share price and are therefore very volatile. For example, a 1% movement in the share price might result in a 10% price movement in the warrant price," observes Lowcock. He points out that investors could lose out if they don't purchase the shares before the warrant expires.
Gibbs notes that warrants produce no income, as they do not qualify for dividends, and warrant holders have no voting rights.
According to Alcraft, the advantages of warrants include the high liquidity of the market and the fact that you only have to invest a small amount of money to gain exposure to the full movement of the underlying share. "This increases the potential upside," he claims.
Alcraft agrees with Gibbs and Lowcock about the drawbacks of warrants, and says: "It can be difficult to find information about warrants. Not all prices are listed in the main financial press, and information and analysis is scarce."
But it is the convertible bonds and preference shares that financial advisers have their eyes on in terms of expecting an increase in future issuance, and they are the ones that investors should pay more attention to.
Gibbs points out that they offer a fixed level of income that is appealing when interest rates are low, "although the risks involved in holding these shares rather than keeping money in cash should be taken into account".
According to Lowcock, convertible bonds could become more popular. "Companies need to give a reason for investors to lend them money. A good rate of return in this climate would do that. The option to convert gives the investor the choice."
Faced with all these options, it is imperative that investors do their homework when choosing a share class to buy.
One of the most important issues to consider is how secure you believe the company is. If the firm is looking dicey, think about whether you will be first in line to get your money back if it goes down the pan.
This is an updated version of an article that first appeared in Money Observer's March 2009 edition.
Generally speaking, insolvency is to businesses what bankruptcy is to individuals. A company is insolvent if the value of its assets is less than the amount of its liabilities, or it is unable to pay its liabilities (loan payments) as they fall due. It’s an offence for an insolvent company to keep trading, so the main options available to an insolvent company are: voluntary liquidation, compulsory liquidation, administration or a company voluntary arrangement.
A stockmarket security (a form of derivative) issued by companies on their own ordinary shares to raise capital. A warrant has a quoted price of its own that can be converted into a specific share at a predetermined price (called the conversion price) and future date. The value of the warrant is determined by the premium of the share price over the conversion price of the warrant. Warrants give the same economic exposure to an underlying security without actually owning it, and cost a fraction of the price of the underlying security.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
A financial adviser who is not tied to any financial services company (such as a bank or insurance company) and is authorised by the Financial Services Authority (FSA). They can advise on financial products to suit your circumstances. All IFAs have to give consumers the choice of paying by fees or commission and have to explain which would best suit the customer in that particular instance. Also, if commission is paid either by the client or the financial service provider recommended by the IFA, the IFA must disclose what that commission is.
An individual employed by an institution to manage an investment fund (unit trust, investment trust, pension fund or hedge fund) to meet pre-determined objectives (usually to generate capital growth or maximise income) in prescribed geographic areas or investment sectors (such as UK smaller companies, technology or commodities). The manager also carries the responsibility for general fund supervision, as well as monitoring the daily trading activity and also developing investment strategies to manage the risk profile of the fund.
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.
The Financial Services Authority is an independent non-governmental body, given a wide range of rule-making, investigatory and enforcement powers in order to meet its four statutory objectives: market confidence (maintaining confidence in the UK financial system), financial stability, consumer protection and the reduction of financial crime. The FSA receives no government funding and is funded entirely by the firms it regulates, but is accountable to the Treasury and, ultimately, parliament.
Every limited company must hold an annual general meeting for its shareholders once a year to consider the company’s accounts, reports of directors and auditors and it is the only opportunity for shareholders to express their feelings to the board of directors. Shareholders also vote on the appointment/re-appointment of directors, although this may be sent to shareholders as a postal ballot.